Office, international REITs seen strong for 2007

Feb 5, 2007 @ 7:40 am

By David Hoffman

PHILADELPHIA — Real estate investment trusts that focus on office properties and those investing internationally will continue to show strong performance this year, even though REITs overall have outperformed the broad market for the past seven years, according to industry experts.

Office REITs began to cement their leadership position in 2006 and are expected to continue to build upon that success this year, said Glenn Doggett, assistant director of the real estate group at Charlottesville, Va.-based research firm SNL Financial LLC.

They represented the best-

performing segment of the REIT market last year with a total return of 45.22%, according to the National Association of Real Estate Investment Trusts in Washington.

The FTSE NAREIT All REIT Index delivered a total return of 36.05% last year, beating all the major U.S. equity benchmarks. The Standard & Poor’s 500 stock index rose 15.79%, the Nasdaq Composite Index was up 9.52%, and the Dow Jones Industrial Average jumped 16.29% in 2006.

There are a variety of reasons why office REITs should continue to outperform, Mr. Doggett said, including the fact that in various regions — particularly vibrant cities — demand for space is strong, and the ability to bring on supply is limited and extremely costly.

For many years, retail REITs were the leaders, but that changed in 2005 when office and multifamily residential REITs started to catch up, he said.

But industry experts have cooled on multifamily REITs.

Their outperformance was attributable to the fact that home prices were high, forcing many people to stay in apartments while also allowing landlords to charge higher rents.

Home prices have come down, however, leaving office REITs the clear leader.

Acquisition interest

“In the office sector, things are picking up,” Mr. Doggett said. “That’s where you’re seeing them being a major acquisition target.”

For example, the Blackstone Group, a private-equity firm in New York, late last month raised its bid for the Equity Office Properties Trust of Chicago — the largest office REIT in the United States — to $54 a share, from its previous bid of $48.50, topping a rival $52-per-share bid led by Vornado Realty Trust of New York.

That mergers-and-acquisitions activity is expected to continue, said Christopher Reich, portfolio manager for the ING Global Real Estate Fund and the ING International Real Estate Fund, both subadvised by ING Clarion Real Estate Securities LP in Radnor, Pa.

And that is good news for investors, he said.

“In the U.S., there has been a significant amount of M&A, and a good portion of that has been private entities’ taking public REITs private,” Mr. Reich said. “To us, that says the private market [is] looking at it and saying it looks cheap.”

Nevertheless, some financial advisers said they are leery of investing in REITs.

REITs have outperformed for so long that it seems almost imposable that they will continue to be able to beat the broad markets, said James Kibler, president of Eldridge Financial Planning LLC in New York.

“From a long-term perspective, they certainly have a place,” he said.

But Mr. Kibler is cutting back his exposure to REITs.

He isn’t alone.

“I’ve been in and out of real estate many times over my years, and this is not the time to be buying REITs,” said Lewis J. Altfest, president of L.J. Altfest & Co. Inc. in New York.

REIT fundamentals

Other industry experts, however, disagree.

The fundamentals underlying many REITs — particularly office REITs — still are solid, said Robert Steers, co-chairman and co-chief executive of Cohen & Steers Capital Management Inc. of New York.

Of course, that doesn’t mean that all REITs are created equal.

The best office REITs will be those in “24/7” cities, such as New York, Mr. Steers said. Such cities have strong economies where it can be expensive to build, and therefore, rents will be higher, Mr. Steers said.

REITs that invest overseas also should fare well, he said.

The REIT structure still is fairly new overseas, which means that there is greater opportunity for earnings growth internationally, versus domestically.

Three years ago, there were just two REITs in Japan, according to Samuel A. Lieber, chief executive of Alpine Woods Capital Investors LLC of Purchase, N.Y. Now there are 41, he said.

“That’s meaningful,” Mr. Lieber said. “The whole environment is shifting, and I think for people who see it and figure out how to play it, you can make a lot of money internationally.”

But investing internationally can be tricky.

For example, Mr. Reich said, one of the REIT markets he likes is Singapore — but only central Singapore, not the outlying city neighborhoods. Rents in central Singapore tend to be higher, he said.

Even if they think that portfolio managers have the expertise to make such calls, advisers said, they still aren’t going to allocate any more of their client’s assets to REITs.

You can’t say certain regions in the United States haven’t experienced bubbles, said Patrick Hanratty, a managing director with Capital Advisors Ltd. in Cleveland.

As a result, Mr. Hanratty said, he is perfectly happy to allocate just 1% to 2% of his clients’ portfolios to REITs.

Such concern is understandable, given the long period of outperformance by REITs, Mr. Steers said.

Eventually, that outperformance will end, he said.

But if it comes to an end now, it will have less to do with the fundamentals that underpin REITs and more to do with the way other equities are perceived, Mr. Steers said.

‘Favorable environment’

If investors discover that they can get returns in the 15% to 20% range from equities, then capital might flow out of REITs, causing them to underperform, he said.

But Mr. Steers isn’t convinced that the end is near.

“Real estate fundamentals are quite strong around the world, but I don’t think it’s the fundamentals that well determine what the future returns will be,” he said. “It’s going to be how that asset is viewed, and as far as I can tell, it’s still a very favorable environment.”


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