October 27, 2009
US Reit results may sober up stock rally
(NEW YORK) Most property-owning real estate investment trusts (Reits) will begin reporting third-quarter results this week against a backdrop of spectacular industry stock rallies even as rents and occupancy rates are falling.
Will weak fundamentals finally hurt the stocks during the worst commercial real estate downturn in about 20 years? 'Underlying fundamentals over the last year probably will show up in a more pronounced fashion probably this quarter, compared with the somewhat benign numbers of the first couple of quarters,' Michael Knott, senior analyst at independent research firm Green Street Advisors, said.
He noted that the sector is fairly valued.
Despite weak fundamentals, the stocks have rallied, with the benchmark MSCI US Reit Index up 10.4 per cent year to date and up 90.9 per cent since the low of March 6, when capital markets were at their tightest.
Fuelling the soaring stock prices is the ability of Reits to raise capital.
From Jan 1 through Oct 19, property owning Reits raised US$19.3 billion by issuing new shares and US$7.1 billion via corporate bonds, according to research firm SNL Financial.
As the credit markets improved, stocks of the badly bruised sector rebounded.
'From March and April they were what I would characterise as a binary trade: Will they survive or will they perish?' said Richard Imperiale, president of Forward Uniplan Advisors, which has US$720 million of assets under management. 'When the capital markets opened up and allowed Reits to begin equity again that answered the question.'
'Real estate is a derivative of credit and the economy. So credit has clearly improved, and the economy is showing signs of improvement, ' Sandler O'Neill Reit analyst Alexander Goldfarb said, adding that he believes that Reit stocks are justly valued.
Valuing the stocks requires balancing various metrics such as price-to- funds from operations (FFO), which measures real estate performance; price to the value of the underling real estate or net asset value (NAV); and returns against other types of investments.
'You can't focus on any one metric. You're going to use them all in conjunction with one another,' SNL Financial senior industry analyst Jason Lail said.
The overall sector trades at about 111.7 per cent price to NAV and 11 times price to FFO.
Green Realty Corp was scheduled to report earnings after the market closed yesterday. Its stock has soared 63 per cent so far this year and 351 per cent since March 6. Mr Knott rates the stock 'sell' because of its soaring price.
New York-based SL Green's shares trade at 139.6 per cent of the company's NAV, compared with the office sector's 106.7 per cent, according to SNL Financial.
The Reit is highly leveraged with about a 70 per cent debt relative to its asset value, compared with a sector average of about 55 per cent.
'It's highly leveraged, so as things get better that magnified the increase in value,' Mr Knott said.
Since July 1, 2008 SL Green chief executive Marc Holliday hasn't bought any of the company's stock, according to executive compensation research firm Equilar. Chief financial officer Gregory Hughes and president Andrew Mathias sold shares within that period.
Because of the time it takes to sign leases and for free-rent periods to expire, the decline in rental rates over the past three quarters will likely begin to show up in the third quarter.
'I think we're entering the period of time where the next 12 months will be the worst four quarters in actual reported results even though, you can make an argument that the worst declines in the actual market fundamentals have already happened,' Mr Knott said.
News of a bigger-than expected drop in rent and occupancy could depress any Reit stock, Mr Goldfarb said. A revenue rise could fuel share prices. Also, the ability for a company to meet upcoming debt will influence the price, he added.
Reit results may serve as a window into the state of private real estate. Regional banks and thrifts are heavily exposed to the US commercial real estate because they hold a disproportionate amount of mortgages and construction loans.
'Where occupancy is down and rents are decreased most likely you're going to see very similar events within regional banks,' Bliss Morris, chief executive of First Financial Network, which helps place bad loans from banks.
Martin Koh/ Sherry Tang