There's good news and bad news for REITs. The bad news is that real estate stocks tend to be late-stage cyclicals, so analysts don't expect much of a rebound until next year.
Meanwhile, distressed sales of commercial properties will begin hitting the market, depressing prices further.
But the good news is that publicly traded real estate investment trusts are much better positioned than private-real-estate investors to weather the storm and take advantage of fire sales of properties.
Indeed, publicly traded REITs have been busy raising equity capital through secondary offerings. They're using the funds to cut debt, and the stronger players are raising extra cash to make acquisitions.
Through June, REITs have raised $15.6 billion via 50 equity offerings, according to the Washington-based National Association of Real Estate Investment Trusts.
To put that in perspective, public REITs have a total debt of about $150 billion, said Steve Brown, New York-based senior portfolio manager for the American Century Real Estate Fund, advised by American Century Investments of Kansas City, Mo.
“We expect another $10 to $20 billion in equity will be raised over the next 12 months,” he said.
That second round of capital raising will be done for opportunistic purposes as distressed properties come on the market, according to analysts.
Banks will be more inclined to foreclose on non-performing -commercial-property loans now that they have strengthened their balance sheets, Mr. Brown said.
Without access to the public market, the private market will be forced to sell, observers said.
“There will be a lot of defaults,” said Bill Acheson, an analyst with The Benchmark Co. LLC, a broker-dealer based in New York.
BUYING OPPORTUNITY
REITs may be among the few buyers for troubled properties, said Thomas Bohjalian, a portfolio manager for the U.S. realty income portfolios run by Cohen & Steers Inc. of New York.
“REITs with access to capital have a tremendous acquisition op-portunity for the next three or four years,” he said.
“That's why we raised capital to invest,” said Kyle O'Connor, a principal at Marcus Partners Inc., a Boston-based private-real-estate investor, which recently raised $210 million in a private-investment fund.
Non-public markets have yet to see the kind of downward re-pricing that has occurred among publicly traded REITs, he said.
Prices for privately owned commercial real estate probably won't drop as severely as the 70% to 80% fall suffered by REIT stocks since October 2007, Mr. O'Connor said.
But capitalization rates — the ratio of net operating income on a property to its value — have risen to about 9%, from 6%, he said, indicating weak pricing. Combine that with an expected 10% to 20% drop in rents, and private-commercial-real-estate prices could end up falling about 40% to 50% in total.
Because commercial-real-estate transactions have been rare, it's hard to judge where prices are now, Mr. O'Connor said, “but we may be halfway through it [and will] probably accelerate to a bottom over the next year.”
Meanwhile, REIT investors will have to be patient in waiting for good values to play out, analysts said.
REITs tend to be late-cycle stocks that lag behind other sectors of the economy.
That's because longer-term leases can constrain their growth even as the economy recovers, Mr. Bohjalian said.
Distressed sales might provide an opportunity for buyers and contribute to earnings, Mr. Acheson said, but low prices might also put a damper on rents.
“If you have to compete with the guy across the street who bought [an office property] cheap and can offer lower rents, you [may] have to match” those lease rates, he said.
As the economy comes out of recession, “you want to be [in] more-cyclical REITs with short-term leases, like apartments, hotels and industrial companies,” Mr. Bohjalian said. These types of properties are the first ones to participate in rent upswings.
E-mail Dan Jamieson at [email protected].
