The rally in bonds from real estate investment trusts that's made property debt the best performer this year is overdone as a slowing economy may threaten their performance, according to Pacific Investment Management Co.
Debt from REITs, which operate retail, office and industrial properties, has gained 7.3 percent this year, including reinvested interest, trumping the 4.2 percent return from investment-grade debt and 2.9 percent from high-risk, high-yield bonds, according to Bank of America Merrill Lynch's U.S. REIT Index. The debt has faltered in June after five consecutive months of gains, losing 0.45 percent.
“I personally don't think that the underlying fundamental improvement in the REITs has been all that impressive,” said Mark Kiesel, global head of corporate bond portfolio management at Pimco, the world's top bond-fund manager. “If you believe the fundamentals have softened for the U.S. economy, REITs are probably not an asset class you want to be exposed to.”
REITs were pummeled in 2007 and 2008 by the drop in property prices and a decline in occupancies and rents fueled by the worst recession since the Great Depression. The companies regained access to funding last year, selling more than $20 billion of equity, data compiled by research firm SNL Financial and the National Association of Real Estate Investment Trusts trade group show. This year, REITs have issued bonds at the fastest pace since 2006, selling $8.03 billion through June 9, Bloomberg data show.
“The opening of the equity markets has really pushed out the liquidity problems of the REITs,” Kiesel, who helps oversee $300 billion of credit investments, said in a telephone interview.
Bonds from real estate companies, 92 percent of which are REIT debt, have had the best year-to-date returns of 16 industry groups tracked by Bank of America Merrill Lynch, with an 8.3 percent return. Insurance debt is the second-best performer at 5.9 percent, followed by services, 5.25 percent. The lowest returns came from energy issuers, up 2.2 percent.
REIT shares have also outperformed the broader market, gaining 7 percent this year through yesterday, including reinvested dividends, according to the Bloomberg REIT Index. That compares with a 4.5 percent decline in the Standard & Poor's 500 Index.
“The REITs have experienced the bulk of the benefit of improved markets,” said Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, who said his firm has a “market-weight” rating on the sector. “Most of the refinancing and liquidity and rate benefits are now behind us.”
Markets have been rattled by Europe's sovereign debt crisis, causing stocks to fall in May, and Treasuries to gain. Investors are concerned about the pace of the economic recovery, after a Labor Department report on June 4 showed that employers in the U.S. hired fewer workers in May than forecast and that Americans dropped out of the labor force.
Federal Reserve Chairman Ben S. Bernanke said yesterday that the U.S. recovery is being restrained by the housing and commercial real-estate markets, in a testimony prepared for a House Budget Committee Hearing.
“The REITs represent a risk given current levels,” said Kiesel, who favors long-dated Treasuries and U.S. bank bonds. “You've seen a huge run-up in asset values, the equity, and the bond spreads have tightened. At the same time you're seeing growing risks of a slowdown in the U.S. economy. Those two are inconsistent.”
REIT debt will also face pressure from a jump in supply during the next couple of years, said Timothy Daileader, director of research at financial-services firm Knight
Capital Group Inc. in Greenwich, Connecticut.
This year's REIT-issued debt is about $600 million short of matching total sales in 2009, Bloomberg data show. In 2006, REITs sold $8.89 billion of bonds through June 15.
The 25 biggest REITs have $22 billion of secured and unsecured debt maturing through 2012, according to data compiled by Knight Capital.
“Our thesis is that the unsecured bond market is going to be weak for REITs because of the amount of supply that's coming,” Daileader said. “If you're going to buy it, buy short-term maturities. The longer-dated stuff will have more price pressure on it than shorter-dated.”
