By John Spence
A DOW JONES COLUMN
Merger talk centered on real estate investment trusts pushed
exchange-traded funds tied to the sector to fresh recovery highs,
shaking off most concerns that commercial real estate could be the
next shoe to drop after the credit crunch.
SPDR Dow Jones REIT ETF (RWR) registered a 52-week high last
week after ProLogis (PLD) and AMB Property Corp. (AMB) confirmed
media reports they are in merger negotiations. (The companies
announced the merger early Monday morning).
The ETF rose to a one-year high of $63.55 a share Friday before
tumbling along with stocks as escalating protests in Egypt unnerved
markets. The fund has recouped about half the losses it suffered in
the 2008 financial meltdown.
"In the near term, we expect acquisitions will be the primary
growth vehicle for many REITs," analysts at Keefe, Bruyette &
Woods said in a Jan. 24 note.
REITs scaling a new recovery high has been lost in the shuffle
with popular stock benchmarks such as the S&P 500 Index and Dow
Jones Industrial Average recently touching key hurdles of 1300 and
12000, respectively.
The quarterly reporting season for REITs is getting into full
swing. Deutsche Bank said REIT valuations "appear relatively full"
in a sector earnings outlook.
"However, with fundamentals on the mend, commercial real estate
debt markets continuing to open and the potential for dividend
increases to broaden, we remain positive," Deutsche Bank analysts
wrote. "In 2011, REITs could benefit from a stronger-than-expected
deployment of capital by investors and a more robust economic
recovery."
Investors' hunger for income and their struggles with low bond
yields may be driving some of the interest in REITs, which are
required to pay out most of their profit as dividends to qualify
for tax breaks. Subsectors include apartments, offices, malls and
self-storage.
Vanguard REIT ETF (VNQ) is the largest exchange-traded product
by assets for real estate. The Vanguard fund was up 37.9% for the
year ended Jan. 26, outperforming the S&P 500 by nearly 17
percentage points, according to investment researcher Morningstar
Inc.
Other popular options include iShares Dow Jones U.S. Real Estate
Index Fund (IYR) and iShares Cohen & Steers Realty Majors Index
Fund (ICF), which yields 3%, according to manager BlackRock Inc.
(BLK).
"The market pendulum is constantly shifting from the desire for
capital appreciation, to an income focus," said Michael Gayed,
chief investment strategist at Pension Partners LLC.
"If bonds rally in the near-term, then you'll likely to see
leadership in income-oriented areas of the stock market" such as
utilities and REITs, which can cause the sectors to hold up even in
a market correction, he said.
Shaky Ground
Other analysts say REITs could cool somewhat in 2011 after their
solid run.
Following two consecutive years of returns in excess of 20%, the
sector "will take a breather" and "will come down back to earth"
this year, Jefferies & Co. analysts wrote in their outlook.
They're estimating a return of about 6% for the REITs they
cover.
"We also expect capital markets to remain receptive to REITs,"
Jefferies added. "That said, rising interest rates will be a
headwind."
Indeed, hundreds of billions of dollars of commercial real
estate mortgages need to be refinanced in coming years. Default
rates have been rising after the credit crunch, while occupancies
have fallen. Some bears are predicting a looming shakeout similar
to the housing bust on the residential side.
"During the past decade, REITs benefited from increasing
leverage, lower borrowing rates, rising property values, and strong
growth in demand for properties," Timothy Strauts at Morningstar
said in a recent analyst profile on Vanguard REIT ETF.
"Looking forward, it is unlikely REITs will enjoy so many
positive trends at the same time," he wrote. "And while interest
rates remain low at this time, rates will eventually rise, and this
will increase REITs' cost of capital, pressure asset values and
reduce cash flow."
(John Spence is a writer for MarketWatch. He can be reached at
415-439-6400 or via email at AskNewswires@dowjones.com)