May 19, 2009 1:35 pm

Stronger focus on fundamentals cools REIT rally, for now

This article is provided to readers by dealReporter—a news service focused on providing insightful intelligence on event driven situations to investors.


Since 1 March public REITS have had a tremendous run with more than 20 raising capital following institutional demands for new equity, dealReporter reports. Although the MSCI US REIT Index increased 25% during this time, over the last week it has fallen 10%, reversing the trend.

One institutional investor said “there is concern that at USD 10bn (in equity issued)... maybe the bellies are full for a while.”

A second institutional investor said the sector was too focused on liquidity rather than fundamentals.

REIT experts predict fundamentals across all REIT sectors to deteriorate over the next 12-18 months due to miserable GDP growth and an estimated 9% unemployment rate by the end of the year. Several sell-side research desks are predicting negative FFO growth of 10% in the sector for the rest of the year.

Continued deterioration in real estate value, dysfunctional CMBS and unsecured markets are expected to increase cap rates by as much as 300bps to 500bps, they said. Since the beginning of last year CMBS AAA spreads increased by 780bps while corporate AAA spreads widened 166bps.

Still, for more than 40% of all REITs with leverage ratios exceeding 10x, the deleveraging process has just begun. While USD 2bn dividend cuts and around USD 10bn in new equity will help improve liquidity, more capital will be required to support over USD 45bn of debt maturing by 2010, according to dealReporter estimates.

A second institutional portfolio manager said that higher quality REITs were the first to raise equity and are being followed by B-class REITs.

Unfortunately, the recent equity issuances by Forest City (NYSE: FECA) and Kite Realty (NYSE: KRG) were disappointing, the investors said. The second wave of equity issuers are looking at substantially higher discounts to pique investors’ interest.

Forest City offered 40m shares with pricing guidance between USD 6.60 and USD 7.00 per share. While Forest City was oversubscribed by 5.5m shares it closed below the offering range at USD 6.30 per share Thursday. Kite offered 25m shares with guidance between USD 3.20 and 3.60 according to a buysider. Kite closed at USD 3.33 per share Thursday with a less then impressive response from buysiders.

Still, the portfolio managers believed any pause will not be permanent with some REITs now entering the next stage of funding efforts, namely right-sizing balance sheets while others are still in the first stage, raising defensive capital to deal with maturities.

The institutional investor argued Simon Properties was moving into the third stage of consolidation, but many of the REITs were still in the first stage with a lot more “wood to chop”. Brookfield Properties (NYSE: BPO BBB), Alexandria Real Estate (NYSE: ARE), Douglas Emmett (NYSE: DEI) may be entering the markets with new equity offerings or to seek secured financing.

The strongest variable within REITs, with demand cooling off and investors become more selective, are the attractive yields that have so far outweighed concerns over REITs’ weak fundamentals and excessive leverage. REIT yield in May has been 453bps above the S&P 500 dividend yield and 360bps above the 10-year Treasury Yield. However, the recent pull back in equities is starting to pressure spreads, while slowing demand for REIT equity.


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