US economic wild card could derail REIT's despite good fundamentals

Posted On Wednesday, 07 May 2008 02:00 Published by
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Given fears that a sagging economy and a crippled credit market might wreak havoc on the commercial property market, real-estate investment trusts delivered surprisingly strong earnings for the first quarter, with many companies beating analysts' estimates

An analysis by Keefe, Bruyette & Woods of 64 REITs or real-estate operating companies that have reported first-quarter earnings as of Monday found 32 had exceeded analysts' consensus expectations, after adjusting for nonrecurring items. An additional 16 met expectations, and 14 missed. Two of the REITs had no meaningful consensus estimates.

The generally solid performance appears to justify the sector's rally over the past two months -- with the SNL U.S. REIT Equity Index up 14%, compared with 6% for the Standard & Poor's 500-stock index.

"We're not getting these monstrous misses that some observers might have expected going into earnings season," says Richard Anderson, director of REIT research for BMO Capital Markets.

Of course, the U.S. earnings season isn't over, so the tally could change. But executives and analysts say that the generally positive results so far reflect the property market's strong fundamentals. The U.S. commercial real-estate market benefited from limited new supply coming online in the earlier part of this decade, thanks to competition for land from home builders and high construction costs.

Nonetheless, REIT executives are cautious about the outlook for the rest of the year, saying earnings could suffer if job losses continue. Of the 32 companies that beat estimates, only 12 raised earnings guidance for 2008. That indicates that either Wall Street was too conservative for the first quarter or that many companies expect a slowdown later, says Sheila McGrath, senior vice president for Keefe, Bruyette & Woods.

For example, BRE Properties Inc., a San Francisco apartment company had a strong first quarter with 4.2% net operating income growth, year over year. Constance Moore, BRE's chief executive, said in an earnings call with analysts that while she was maintaining her initial guidance, "given the range of regional economic conditions, strong in certain markets, recessionary in others, this is going to be a challenging year and perhaps longer."

Moreover, for some REITs, such as those that specialize in office buildings, there is a lag time between job losses and tenants vacating space because of multiyear leases. Even in Manhattan, the strongest U.S. office market, with a tight vacancy rate of less than 6%, layoffs on Wall Street are expected to eventually make a dent in landlord earnings.

So far for the year, REITs that specialize in self-storage units are the top-performing group, with total returns, including dividends, up 24%, followed by apartment companies and shopping centers, up 15% and 10%, respectively, according to the National Association of Real Estate Investment Trusts, a trade association.

One factor helping apartments is declining rates of homeownership. Around 1.5 million households have left the ranks of homeowners during the past few years amid the property slump. Many of those have become renters.

Nonetheless, the backlash from the single-family home and condominium downturn has hurt some markets. Camden Property Trust, for instance, saw weakness in its northern Virginia properties. Folks unable to sell homes and condos there and in markets such as Florida, Las Vegas and Arizona are instead putting them on the rental market, creating new competition for the apartment REITs.

Looking forward, whether apartment REITs can maintain their strength will depend on the job growth situation, says Mike Salinsky, analyst at RBC Capital Markets. In general, apartment performance closely tracks job growth. As the number of jobs shrink, people tend to double up with friends or move in with family, depressing demand for apartments.

Another thing to watch: the summer-leasing season when a disproportionate share of annual apartment leases are signed. The period will be a critical test for apartment landlords given the uncertainties in the economy, says Alexander Goldfarb, analyst at UBS AG.

For retail REITs, first-quarter results have revealed steady performance that so far has largely escaped fallout from the slumping economy. Analysts had expected retail REITs to report declines in occupancy because consumer spending has slowed and store closures are forecast to multiply. Indeed, the International Council of Shopping Centers recently boosted its forecast of U.S. store closures for this year to nearly 6,500 from 5,800, putting the tally on track for its highest total since 2001.

Yet mall REITs and their peers in the shopping-center market generally held up last quarter, illustrating that the landlords are less susceptible than their tenants to short-term swings in consumer spending -- as long as those tenants keep paying rent. The REITs' growth in net operating income slowed last quarter, but not drastically.

Among the retail REITs showing slight strain last quarter was Equity One Inc., an owner of shopping centers in the Southeastern U.S. Equity One's primary market, Florida, has suffered significantly amid the housing market's turmoil. In turn, Equity One's occupancy rate fell to 92.7% in the first quarter from 94.1% a year earlier as closures of video stores and restaurants took their toll.


Publisher: Wall Street Journal
Source: online.wsj.com

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