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REIT Valuations by Sector Macquarie Capital Partners Market Overview Q1-2002
Builders, the report says, will need to add 1.7 million new homes and apartments a year to keep up with the demand. The number is greater than the annual rate of household formation because it includes replacements for old homes that are destroyed, as well as demand for vacation homes. In the past three years, builders have been adding only about 1.6 million new homes a year, in part because of constraints on land use that have made it harder to find places to build. The report also stated that it is unclear whether the immigration boom will continue, especially if the U.S. tightens its borders further in response to terrorist threats.
There are, however, a number of risks involved in subleasing of which a prospective subtenant needs to be aware. First, the prospective subtenant should confirm that its intended use of the sublease space is permitted under the master lease. Second, in the event that the master lease requires a landlord's consent to any sublease, a prospective subtenant should be looking to obtain that consent prior to incurring expenses to negotiate and draft the sublease document. Third, the master lease may entitle the landlord to share in any subleasing profits (the per-square-foot amount of rent due under the sublease, on a pro rata basis, in excess of the rent due under the master lease). Finally, some master leases may grant the tenant certain early-termination rights. These early-termination rights must be addressed in the sublease document. The sublandlord's ability to voluntarily terminate the master lease creates a significant degree of uncertainty with respect to the term of the sublease. Subleasing may present an ideal solution to your current space needs, but unless you take a good look behind the curtain, your bargain could turn out to be a bust.
Moves to the larger-cap 1000 index from the smaller-cap 2000 indexes would ordinarily be considered a good thing for the sector, since it means the market caps of those companies are increasing. And the smaller-cap indexes are likely to get almost all of the 19 additions. But since many of the new stocks will have market caps below those of the companies being shifted to the Russell 1000 index, the smaller-cap indexes' weighting in real-estate stocks - which is based on market cap - will drop. According to the latest data, the percentage of real-estate stocks in the Russell 2000 would drop to 6.9% from 7.9%, currently its fourth-largest sector weighting. The percentage for the Russell 2000 Value would fall to 10.3% from 12.1%, that index's second-largest sector weighting. Meantime, it's not clear whether the move into the Russell 1000 will help those REITs, beyond adding prestige, analysts say. Real estate represents only 1.5%, 2.5% and 0.2% of the stocks in the Russell 1000, 1000 Value and 1000 Growth indexes, respectively. And large-cap fund managers may not want to add more real-estate companies in their funds, preferring to just increase positions in stocks they own. Potential additions to the Russell 3000 Trizec Properties, America First Mortgage Inv, Anworth Mortgage Asset, Apex Mortgage Capital, Center Trust Correctional Properties Trust, FBR Asset Investment, Heritage Property Inv Trust, Impac Mortgage Holdings, LTC Properties, National Health Realty, NovaStar Financial, Omega Healthcare Investors, Price Legacy, RAIT Investment Trust, Ramco-Gershenson Properties Trust, Transcontinental Realty Investors, Urstadt Biddle Properties and Wellsford Real Properties. Real-estate companies potentially moving to Russell 1000 from Russell 2000 Annaly Mortgage Management, BRE Properties, Camden Property Trust, CenterPoint Properties Trust, Cousins Properties, Developers Diversified Realty, First Industrial Realty Trust, Forest City Enterprises, Highwoods Properties, Reckson Associates Realty, Regency Centers, United Dominion Realty Trust and Weingarten Realty Investors. [Note: wished article had said the percentage of REITs held in index funds and those that try to mirror the indexes, so we could judge the degree of the effect of these changes.]
While some real estate professionals are trumpeting the fact that 'we' did not overbuild in 2001, there is too much space entering the market right now. This conflict can be resolved by the simple developer explanation that it is not their fault. Blame for the rising vacancy and falling rents of 2001 lies with demand and not supply.
Although most property markets rose and then crashed together in the late 1980s, it is incorrect to consider them as one real estate cycle, which behaves uniformly across all property types. Cycles of various property types rise and fall for different reasons. The movements of some property types are closely related to the U.S. economy. Thus, the cycle for these is largely due to the demand side of the marketplace. In these cases, real estate echoes the economic cycles. Other property types, however, have much longer swings that bear almost no relation to broader economic cyclicality. For multi-housing and industrial property, supply movements echo demand flows. Thus for these two property types rents follow supply, which follows demand. The implication is that both of these sectors have much less risk of overbuilding due to supply alone. Office property differs from this pattern. During the last thirty years, the office market has experienced two big building booms, while demand has undergone five cycles. Since the frequency of demand differs greatly compared to supply fluctuations, they are not explained by simply lagged changes in either variable. Rather than an echo to demand shocks, office supply has a life of its own. Office market rents also clearly move with supply and not demand. Rents are at a peak during the demand downturn of 1980-1982 and are at a bottom during the strong demand growth beginning in 1992. The risk in office property investment is associated with a periodic "self-overbuilding" that is not related to economic demand shocks. Neighborhood and community [retail] centers have a high correlation to the economy, but regional centers [malls] do not. TWR's research has indicated that several factors generate an endogenous real estate cycle in some sectors (office, regional retail centers, and hotels), but not others (multi-housing, industrial, and neighborhood/community retail centers). A property market is more likely to have a long-run endogenous cycle when supply is more elastic than demand, when there are long lags in the delivery of new space, when there are high rates of physical or economic obsolescence, and when the underlying demand for space is fast growing. In the case of multi-housing, industrial buildings, and neighborhood/community centers, the development lag is widely known to be quite short, i.e. one year. The housing and industrial stock growth rate has been one to three percent annually. Rental housing has a fairly inelastic demand, and research suggests that multi-housing supply is not very elastic either. The industrial market is also closely linked to the U.S. economy. In contrast, the demand for office space is inelastic while supply is very elastic. The sectors, which drive office space demand, are somewhat insulated from economic cycles. In terms of development time, office buildings and regional centers require considerable time to plan and construct. During the last decades, long-term growth rates for these sectors have ranged from three to five percent. Thus, the risk of investing in these two property types has more to do with the intrinsic overbuilding risk of their own cycles rather than broader economic or systematic risk. [Office rents in suburban areas are always closer to their mean level as it is easier to build an office property in a suburban area with less of a time delay than in downtown sub markets.] Office Market Projection While lenders are generally risk averse, their appetite for risk has varied over time and not always in tune with overall risks in the marketplace. During the early 1990s there were good office properties with decent occupancy levels and balance sheets that could not get refinancing. Quite simply, lenders had been badly burned by loans to the office sector in the recent past and had no appetite for any risk tied to real estate. Financing for new development virtually came to a halt during the early 1990s. Construction reflected this, falling to zero in many markets. The pull back was necessary considering additional office space was not needed. Since the early 1990s, improvements in the lending markets have occurred, such as the expanded profile of risk managers at banks, higher pre-leasing requirements and more careful due diligence. Evidence suggests that these improvements have prevented lenders from duffering from a large number of loan defaults. TWR thinks these improvements have protected lenders to date and that today's moderation in lending prevents a huge oversupply of capital and new construction. If that is the case, then capital sources will not swear off the office sector as much or for as long, in the next few years because they will not be as 'severely burned' as in the 1980s. When the demand for office space returns to a better balance, lenders should return and provide financing for new developments. The implication is that less of a downturn in the supply cycle and less of a reduction in vacancy due to a lack of new supply will occur. [From Green Street Advisors Q4-01: The aggregate office REIT development pipeline declined 21% at the end of 4Q-01 vs. 3Q-01, and the industrial REIT pipeline shrank 27% during the same period.] 'Natural' Vacancy Rates? One of the earliest and most potent ideas in real estate economics is the theory that there is a natural vacancy rate (10%) below which rents increase and above which rents decline. TWR has written papers that suggest there is not one vacancy rate, but a range of rates that trigger rent declines or increases, depending on other conditions in the market. Vacancy rates started this downturn at some of their lowest rates in history. From the prospective of a 'natural' vacancy rate, 2001 has just moved vacancy rates toward their long-term average. So, unlike the recession of 1990, there is not the same degree of overhang of vacant space and there should not be the same degree of rent reductions. In comparison to the long term, even the [vacancy] jumps of the last year have not driven rates above their long-term averages in most cases. Unlike the 1990s recession, this real estate recovery will not require five years of reduced rents and a cessation of new building to eliminate the overhang of space. Though 2002 may be an uncomforatble real estate year, it will also be a year to prepare for a recovery. Future Building Expectations The table below shows the estimated real rent level for 2001, along with the most recent growth or decline, as well as real (inflation-adjusted) rent levels at the end of the last recession in 1992. While most property types saw declines in real rents over the year 2001, levels are still well above 1992 levels, particularly in the office market.
It is rent levels that generate incentives to build. Given the cost of land, the level of rents today do ÍpencilÎ to a profitable development deal in most markets and property types. Absent the recession, there is reason to build new space in the current markets. Rents are still high relative to their cycle, and vacancies are still low by long-term average standards. If these performance measures are not overwhelmed by negative net absorption during the downturn, they will make it profitable for developers to introduce new space going forward. Office Towers While the public markets of REITs and Commercial Mortgage Backed Securities have fulfilled their promise of bringing liquidity to real estate, the liquidity exists in the public capital markets themselves. For the trading of office towers themselves however, liquidity has stayed the same as for other real estate assets. In periods when uncertainty abounds, like today neither buyer nor seller is likely to concede to the other's evaluation of the situation. So, while prices have declined, price drops have not matched the quick deterioration in vacancies in many markets. Timing the Rebound This economic recession has had the unusual characteristic of hitting nearly all markets at nearly the same time but it did not hit with the same degree of force in all areas, nor will the rebounds look similar. Real rents do not increase until vacancy is brought more closely to its 'natural' level, so the timing of the real rent turn is an indication of how much overhang will be built up because of the recession. Here, industrial space stick out as taking a particularly long time as it did not have the advantage of starting from a below-equilibrium vacancy rate before the recession, as well as having its sector of demand, manufacturing, particularly hard hit. More on Absorption Green Street Advisors Sector Report 4Q-01 To put '01's horrible results in context, the average office absorption from '90-'00 was positive 70 million sq.ft. annually. Even during the national recession and overbuilding boom of the early-90s, office absorption fell from peak levels but was still positive (ex: 35 million sq.ft. in 1991). REIS forecasts that 87 million sq.ft. of office space will be completed in '02 (a 2.7% addition to the existing stock). The projected deliveries would significantly exceed our best guess of approximately 40 million sq.ft. of net absorption. The excess space would add roughly 150 basis points to the year-end '01 vacancy rate of 13.6%, suggesting that the national office vacancy rate probably will approach 15% later this year.
Particularly today, when the amount of great opportunities out there for real estate companies is as prevalent as up days in the stock market, I am quite happy that the REIT laws impose a kind of "opportunity triage" upon REIT management teams. Simply put, the REIT framework prevents a company from using all of its free cash flow for "the newest new thing," or, in Peter Lynch's view, "Diworsification." There are still plenty of defenders of low payout ratios. Many claim that corporate income growth will be much higher in the future due in large part to those lower payout ratios - which provide huge retained earnings that can be invested to augment companies' growth rates. In a presentation made at the NAREIT Institutional Investor conference in New York last week, a fellow named Rob Arnott, of First Quadrant, provided us with one very shocking chart. It suggests that, between 1946 and 1991, the average company's growth rate over the following 10-year period is highly and positively correlated with its dividend payout ratio. In other words, the higher the payout ratio, the greater the growth prospects over the next 10 years. Related article: Praising Dividends - Clements, WSJ / Lazo, Barrons / Norris, NY Times
Most sellers are hoping to attract out-of-state buyers who want to get ahead of the economic upturn. Whatever the reason, property brokers say that it's been years since so many trophy buildings have been on the block in North Texas. Unlike in the 1990s, when lenders sold billions of dollars in North Texas commercial real estate at cut-rate prices, the current offerings carry hefty price tags. The Galleria complex is expected to fetch more than $300 million. And the downtown Chase Tower will easily top $200 million, agents predict. Investment property brokers say these buildings and other high-dollar deals will most likely wind up in the hands of institutional investors - big funds from America or abroad. Those investors are more concerned with the cost of money and potential return than how much a building costs, investment advisers say. 'The higher-quality assets are attracting the most capital, not only because of yield but the risk profile is relatively low," said Evan Stone, who heads the Dallas office of Eastdil Realty. The availability of capital is tremendous, and from a macro perspective, real estate offers much better yields and security than alternative investments such as stocks and bonds. This is a dramatic shift from the hot stock market of recent memory," he said. "Further, interest rates are near historical lows, and capital that sat out much of last year and needs to be spent.' Many first-class commercial real estate assets are generating 10 percent to 15 percent annual returns, "which beat the heck out of other investment alternatives,' said Mark Gibson, executive managing director in investment banker Holliday Fenoglio Fowler's Dallas office. 'You can invest in trophy real estate and get a confident return - something you can't say about a lot of other investments.' A few years ago, many East Coast investment advisors blacklisted North Texas because of overbuilding. But when it comes to major properties, any bias against investing in Dallas appears to have ebbed, said Jack Minter, who works in the Dallas office of CS First Boston.
The new buildings are arriving when Chicago's commercial real estate market is struggling by some measures. Availability in downtown office buildings hovered near 19% in Q1, the highest rate on record, according to the most recent statistics from the Chicago office of Insignia/ESG. In addition, the amount of sublease space on the market has increased sixfold, to 7.3 million square feet, or 28% of the total available space, according to Insignia/ESG, as many businesses closed their doors or pulled back on expansion plans in the economic doldrums. Despite this abundance of available office space, the developers of the new buildings have had little problem in securing tenants at market rates. Nearly 75% of the space in the four new buildings has already been leased, said Michael Klein, executive vice president for Insignia/ESG's Midwest region. Only one of the new buildings is ready for occupancy. Brokers here say two crucial forces are driving the new construction. The first is that large blocks of contiguous office space available for long-term lease have been virtually nonexistent. The second is that commercial real estate tenants in Chicago tend to lease space for 15 years. A number of large tenants whose leases are expiring in the next three years are in older buildings that cannot accommodate the technological needs of businesses today, said Drew Nieman, a principal of the John Buck Company, a commercial real estate developer based in Chicago. Older buildings sometimes lack the high ceilings and up-to-date electrical and air-conditioning systems necessary for computerized offices. In light of these factors, John Buck and Lend Lease Real Estate Investments made a bet three years ago that the Chicago office market could absorb an ultramodern 50-story, 1.2-million-square-foot glass-and-steel tower that they developed. The $350 million project was begun almost speculatively, with only one commitment to lease a small amount of space. The building, completed late last year, has now leased more than 80% of its office space. After construction began, several large companies, including UBS and PricewaterhouseCoopers, wanted to consolidate their Chicago operations. They could not find the necessary space in any existing buildings, Mr. Nieman said. John Buck has already unveiled plans for a tower of at least 950,000 square feet just a block away from its new building on Wacker Drive. Another major developer, Hines Interests, based in Houston, did not take the risk of speculative development when it decided to build the 37-story, 700,000-square-foot tower now nearing completion. It began making plans to construct the building at 191 North Wacker Drive in 1998 when tenants were rapidly absorbing vacant office space in downtown Chicago and no new office buildings were planned. Hines was able to secure financing after it persuaded the Chicago law firm of Gardner, Carton & Douglas to move from another of its buildings to the new Wacker Drive property. More tenants have since signed leases, committing 65% of the building's office space. The Dutch financial services company ABN Amro is building a 1.3-million-square-foot high-technology center for its exclusive use to put its back-office operations under one roof. The Bank One Corporation of Chicago found its operations spread throughout several office buildings, and decided to consolodate in the new Dearborn Center. The bank's lease of 525,000 square feet was the catalyst for the financing and construction of the 1.5-million-square-foot 37-story building, which should be completed this year. The building is now more than 60% leased.
[From www.reitnet.com: The origins of the real estate investment trust date back to the 1880s. At that time, investors could avoid double taxation because trusts were not taxed at the corporate level if income was distributed to beneficiaries. This tax advantage, however, was reversed in the 1930s, and all passive investments were taxed first at the corporate level and later taxed as a part of individual incomes. Unlike stock and bond investment companies, REITs were unable to secure legislation to overturn the 1930 decision until 30 years later.] The most relevant requirements for a Corporation to claim a REIT tax structure are:
REITs had a lackluster existence until the Tax Reform Act of 1986. Prior to that, the tax advantages of REITs were minor compared to those of limited partner-ships and investors were less familiar with REIT structures. In the '70s, most REIT market growth came from mortgage REITs. When interest rates rose in the mid-70s, many of these REITs went bankrupt due to their leveraged positions. This further dampened investor enthusiasm. Tax Reform Act of 1986, which included the REIT Modernization Act, and triggered considerable growth in REIT assets. The Act included provisions that resulted in a less restrictive tax environment, increasing the attractiveness of REITs relative to limited partnerships and allowing greater management flexibility. However, by the late 1980s, the real estate boom began to slow down again and eventually the market virtually collapsed. The real estate collapse of the early 1990s was precipitated by the savings and loan crisis. Traditional sources of financing were no longer easily available. In order to finance the liquidation of the S&Ls, Wall Street financial engineers developed instruments that brought securitization into vogue. With the popularity of these securities, the popularity of REITs also grew, for REITs, like mortgage-backed securities and their hybrids, are essentially pass through securities. The second landmark event for REITs occurred in November 1991 with the $128 million initial public offering of KIMCO. The low interest rate environment of the early Ì90s and the high yields offered by REITs attracted a number of mutual funds to this category of securities. This development helped a number of new companies go public in 1993 when $9.3 billion was raised through REIT IPOs. In December 1993 Simon Properties brought the largest public offering ever of $800 million. In 1994 the Federal Reserve raised interest rates several times. The higher rates eventually had an adverse effect on REITs and, in the last two quarters of 1994, very few IPOs were launched. This trend continued into 1995. However, existing REITs with good historical performance were able to raise a record amount of capital through secondary offerings. In 1996, the performance of REITs again began to improve. The NAREIT Equity Index, an index of equity REITs, returned 35.0% versus 22.4% for the large cap Russell 1000, 16.5% for the small cap Russell 2000 and 9.7% for direct investment in real estate as measured by NCREIF. Further improvements were made in REIT legislation with the REIT Simplification Act of 1997. While this act addressed certain loopholes in REIT laws, it also provided REITs more flexibility with respect to providing ancillary services to tenants and selling properties. 1998 proved to be the second worst year in REIT history, with REITs (represented by NAREIT's al l REIT index) posting a return of -18.8%. The NAREIT Equity index returned -17.5% for the year. 1998 was a year remarkable in the extent to which REITs moved in a direction opposite to other asset classes. REIT performance was also poor in 1999 with Equity REITs having a total return of -6.5%. This compared to 21.1% for the S&P 500 and 21.3% for the Russell 2000. On December 17, 1999 the REIT Modernization Act passed as part of the Tax Relief Extension Act of 1999. The Act allows REITs up to a 100% stake in a taxable REIT subsidiary which can provide ancillary services to REIT tenants. The Act also eases the requirements on dividend payouts from 95% to 90% of taxable income. The law will go into effect from January 1, 2001. Some Relevant Statistics Considering the size of the real estate market the potential for growth of the REIT market through acquisitions is tremendous. The table below shows current (December 1999) market penetration by REITs by various property types.
More on Market Capitalization Macquarie Capital Partners Market Overview Q1-2002 [Note: I do not know why the figures for 1998 in the tables above and below do not agree - and by such a wide margin.]
More on Market Capitalization Summit Properties Annual Report 2001 And although the equity market capitalization of REITs has increased more than 15 times in the last decade, there is still room for unprecedented growth. The approximately 300 publicly traded REITs control assets of about $300 billion, which is less than the market capitalization of Microsoft and only 8% of the total real estate market, which is estimated at over $4 trillion. National Association of Real Estate Investment Trusts, REITs have provided an average annual total return of 13.3% over the last 20 years. Not bad when you consider over half of this amount is in the form of a dividend and doesn't rely on often volatile share prices. One Off-Topic Note from Summit's Annual Report: I believe the Echo Boomers represent a great opportunity for the apartment industry. Households made up of people aged 20-29 (who are far more likely to rent apartments than any other age group) will increase by nearly five million in the next ten years. That compares with a decline of over four million households in that age group over the past ten years. REIT History & RMA SNL Real Estate Securities Weekly 1-8-01 On January 1, 2001 the REIT Modernization Act (RMA) became effective, allowing REITs to become "active" owners of real estate and to enter lines of business previously off-limits. This legislation will undoubtedly transform the industry, not only through an evolution in operational strategies, but also by affecting how REITs are valued. Reliable and consistent rental income streams have made REITs a safe haven for investor dollars. Some REITs have already announced that they will take advantage of the RMA. Many analysts are leery of what this might mean to the industry, while they also look at the move as a positive advancement. For over 30 years, REITs played a limited role in real estate investment, due to the fact that they were not allowed to operate or manage their properties, but were allowed only to own them. With such a limited role, management teams of REITs often found themselves at odds with the operators or managers of the property. This frustration eventually led to provisions in the Tax Reform Act of 1986, which allowed the economic interests of the REIT owners to be combined with those of the REIT operators and managers. Subsequently, improving fundamentals provided private real estate companies an opportunity to turn to the public markets to access capital. Many investors were responsive, finding that the real estate market was remarkably undervalued during this time period and believing that the market would recover in the near future, resulting in the REIT boom of the mid-1990s. The passage of the RMA grants REITs the right to form taxable REIT subsidiaries (TRS) with which they may invest in ancillary businesses. A REIT can now own up to 100 percent of the equity of a TRS that can provide services to REIT tenants and others without disqualifying the rents as REIT-qualifying income. Jonathan Litt and his research team at Salomon Smith Barney are concerned about alternative sources to REIT earnings. "What we find interesting is that the alternative income streams that a real estate company earns generally results in a lower valuation than a company which owns purely real estate. In the final analysis, right or wrong, companies that try to combine both real estate and alternative income sources will more often than not see their stock trade at a lower multiple than their peers who do not." With the adoption of the RMA, the collective creation of the taxable REIT subsidiaries by REITs has the potential to change REITs from an attractive investment in a somewhat shaky economy into one with lower or more volatile returns. Despite the positive aspects of the RMA, its potential to discourage investors who would otherwise be drawn to REITs in the present economy is one reason to be cautious about the newly enacted legislation. Equity REIT Revenue Detail Equity REITs are growing rental revenues at a slower pace than other income streams. This has influenced many analysts to reduce 2001 estimates.
Source: SNL DataSource: Real Estate Securities Module
Over the past 25 years, a $10,000 investment in GE would have grown to roughly $1.1 million; over the same period, a $10,000 investment in the S&P 500 index would have grown to just under $360,000. A willingness to capture value for shareholders by selling mature assets as well as properties it developed, Cousins has had to return to the equity market only rarely. During the 1990s go-go years for REITs, Cousins sold equity only three times. James Kammert, who prior to joining Goldman, Sachs in the late 1990s, followed Cousins at Robinson-Humphrey, wrote recently, 'Cousins differentiated itself years ahead of the REIT industry through capital recycling and [an] unrelenting focus on shareholder value creation.' In a March 1999 report on Cousins, Green Street Advisors, a buy-side research boutique that focuses exclusively on property-linked stocks, wrote: 'There are several unique aspects of Cousins' game plan. First, management sets an unusually high hurdle rate for deploying capital. While all management teams give lip service to this concept, CUZ's consistent adherence to a high hurdle rate for new investments is the key goal from which other aspects of the company's strategy flow.' The Green Street analysts concluded their report with the following advice: 'Given its long and successful history of value creation, Cousins should be regarded as a core holding for investors looking for exposure to the risks and rewards of development.' The Penobscot Group (like Green Street a buy-side research boutique focused exclusively on REITs and other property-linked securities) says 'Cousins is different from its peers for reasons beyond the size of its development pipeline. Its perspective on opportunity spans multiple property types and an increasing number of markets.' CousinsÌ broad expertise makes it an innovator of new property sub-types. 'Underlying all of this,' the Penobscot analysts added, 'is an understanding that there are far more effective ways of making money in real estate than simply by holding it.' ThereÌs no question that CousinsÌ long-term track record is enviable. The question for investors looking at the company today is whether Cousins can continue to deliver stellar returns for investors. Though there are some unanswered questions, including whether Dan DuPree, Tom CousinsÌ hand-picked successor, can fill his mentorÌs shoes, DuPree is a formidable presence in his own right. He founded New Market Development Co., Ltd. and developed nearly six million square feet of retail space across the Eastern United States before selling that company to Cousins Properties in 1992. From 1992 until 1995, DuPree served as president of CousinsÌ retail division. Over that time frame, Cousins developed an additional two million square feet of retail space. In 1995, DuPree was elected Cousins PropertiesÌ president and chief operating officer. Since its founding in 1958 by Tom Cousins, Cousins Properties has developed more than 20 million square feet of office space, more than 12 million square feet of retail space, including seven regional malls, in excess of 3,000 multifamily residential units, and more than 30 high-quality, single-family subdivisions, ranging in size from 100 acres to 1,500 acres. The companyÌs current portfolio consists of interests in 12.8 million square feet of office space, 3.5 million square feet of retail space, just under one million square feet of medical office space, and more than 300 acres of land for future commercial development. More on Cousins Tad Leithead, Cousins Senior Vice President in its office division, Atlanta Journal-Constitution 6-9 The great thing about having capital is that we're active in an up market and we're active in a down market. When there's not development opportunities, by definition, there are acquisition opportunities. That's not to say that we're vultures. But to the extent that we can go in with our capital and buy a well-located, well-positioned asset, improve it and increase value for our shareholders, we're going to do that. We're aggressively looking for things like that. In an up market, then we'll be primarily developers.
As with most retail rental agreements, Olsson paid a base rent and a percentage of sales, 6% in the Georgetown store's case. Olsson said the base rent continued to climb, eating his profit. The sales figures are private. So is the Olsson's rent. While prime retail locations in the neighborhood rent for $100 a square foot, most go for about $40 to $50 a square foot, a rate comparable to other upscale urban retail markets with lots of foot traffic. Pinnacle/GFZ Realty leases and manages the property for the owner, the Zlotnick Trust. Its vice president, Rich Amsellem, said it was hard to persuade the owner to keep a tenant like Olsson's, which he said is paying far less than the going rate. Olsson's is "paying a rent they can't afford and we can get a rent that's 30 to 40 percent higher than what they're paying," Amsellem said.
Forty of those markets suffered negative absorption, and 39 registered lower effective rents. Importantly, this current multifamily slack is national: The highest levels of negative absorption occurred in Chicago, Atlanta, Houston, Austin, Denver and Phoenix. The greatest effective rent declines occurred in the Bay Area, New York, Austin and Charlotte. On the demand side, all the experts seem to agree on the catalysts of this current downturnÙslack demand tied to the job market, the single-family housing boom, and the departure of corporate housing from the market - and most perceive the currently undiminished supply pipeline with mounting appall. In this apartment REIT close up, we hear from Richard Anderson, multifamily-REIT analyst with Salomon Smith Barney: Job growth won't turn around until the early part of 2003. A lot of REIT managers are basing their analysis on a turnaround in Q4-02, which is not necessarily out of the question, but that would be gravy. Certainly an increase in single-family home sales is a contributing factor. Typically, during a recession we would see single-family home purchases come down significantly. Instead, home sales stayed in line with last year. That's never happened before, and it took people off guard. Another factor is that supply has stayed in the 300,000-unit range in terms of annual starts. We thought going into a recession we would see a dramatic reduction in development activity to the 200,000-unit range. That did not materialize. One reason for this is that with low rates and other financing packages from Fannie Mae and Freddie Mac, developers have been comfortable building properties and moving forward on developments they would never have done if they didn't feel there was going to be a takeout on completion. But private players are out there to buy their new properties, so development has continued. If that attractive cost structure weren't there, supply would have come down. Consequently, there's been weakening in the apartment market. The fact that supply has remained relatively in check has been a good thing from a real estate perspective. Today's weak market fundamentals are mostly due to the demand side. As quickly as we can get growth back into the job market, the fundamentals will improve fairly rapidly. If it were a supply-led recession, it would take two-to-four years for all that supply to get absorbed before we got back on track. The pre-9/11 multifamily sector growth rate was something in the order of 8.5%. That number is now flat to negative-an 800 or 900 basis-point deterioration. With the short-term nature of the multifamily leases, you have a 100% lease rollover exposure. So, earnings growth has come down rapidly, though on the flip side, when things start to improve, it will do so at a quicker pace as well. Valuations Multifamily REITs currently trade at a 10% premium relative to the REIT universe. They historically have traded at a 3% or 4% premium. Why is that the case right now? Over the past two or three years, the multifamily sector enjoyed some of the best fundamentals in the real estate business. In the late 1990s, supply remained in check. Demand was in good shape because of the robust economy. A backdrop to all this is the demographic picture. We are seeing the cohorts that are in their prime renting years - that is 20-29 year olds and the 65 year olds and over - growing in size for the first time in 20 years. Those prime age groups are expected to continue to grow in size for the next 10 to 15 years. People see the underlying demand and, despite what we are going through right now, perceive that this is a safe long-term sector. [Short-term, there are some over-valuation concerns.] There is a lot of uncertainty and lack of visibility in terms of where earnings growth is going to be for many companies. In this period of uncertainty, having premium valuation is a bit scary. However, 2003 and 2004 could be very good years for this group. Buy List Right now, I don't see any multifamily REITs as a strong buy. [At the top of my list of buys would be] Home Properties and United Dominion [Both are Class B, and those REITs are doing better] and [long-term] Archstone-Smith, which is getting out of low-barrier-to-entry markets, like those in Austin, Houston, Phoenix and Atlanta, and moving into high-barrier markets like Boston, Washington, DC . General Preferences We prefer those high-barrier-to-entry markets in the North, where it tends to be difficult to build. The counterpoint is that Southern markets are low-cost-of-living markets, so you will see higher job growth. People migrate more to those markets. You have a net negative move from New York, and you have a net positive migration to Atlanta, which fosters supply growth. We prefer to see minimum supply.
The outlook for suburban office properties dropped from 4.4 in the fourth quarter of 2001 to 4.2 in the first quarter of 2002. Regional malls were among the hardest hit segments, dropping from 6.6 in the fourth quarter of 2001 to 4.9 in the most recent survey. In general, the investors surveyed seemed to feel the retail and lodging sectors will continue to struggle until at least the middle of 2002. The respondents showed more optimism for the industrial and multifamily sectors.
Of the 179 real estate stocks tracked as part of the NAREIT Composite Index, 86 companies have a total market capitalization of $1 billion or less, while 52 companies have a total market cap under $500 million. According to Lee Schalop, real estate equity research analyst with Banc of America Securities, REITs with market capitalizations of less than $1 billion generated an average total return of 30.4% in 2001, while those companies with market caps of more than $5 billion posted an average total return of 9.5%.
For instance, if you compare Developers Diversified and Kimco Realty, you'll find that Developers Diversified's dividend is roughly 400 basis points higher than Kimco's [in the Fall of 2000]. Further, DDR's dividend coverage ratio is higher than Kimco's, 149.3% vs. 147.8%. However, Developers Diversified is substantially more levered than Kimco. (According to a recent analysis by Green Street Advisors, Developers Diversified's leverage ratio was 68.1% vs. 48% for Kimco. Green Street defines that ratio as debt as a percentage of the fair market value of the company's assets.) Put simply, when gauging dividend sustainability, DCR by itself isn't enough. Office Vacancies & Rental Rates Grubb & Ellis Winter 2001
Quick Facts, Stats & Opinions The assessments and forecasts for the Boston commercial real-estate sphere are out. It's a pretty dim outlook, but tolerable, and the recovery is looking to be further out than it was a few months ago. There are more tenants looking to lease downtown, and about 30% of their space doesn't expire until 2004-05. They're starting early, hunting for the deals. Lots of the sublease space expires over the next two years, and it's hard to market. What's needed? Jobs, jobs, jobs. However, of the 10 largest companies looking for space in downtown Boston today, two are growing. Eight are shrinking. (Thomas Palmer, Boston Globe 6-30) Ken Gregory, president of No-Load Fund Analyst newsletter, thinks REITs have more room to run because their yields are so high relative to interest rates. Eric Kobren, publisher of Fidelity Insight and FundsNet Insight newsletters, is also bullish on REITs. 'Earnings seem to be holding up reasonably well,' he says. (Stephen Goldberg, Kiplinger 6-25) Tim Smith, a partner at Horizon Realty Advisors, a Seattle company that owns 12 properties with 2,000 units, and manages another 1,000 units in the Puget Sound area, points out that directly investing in buildings - versus placing money in a real estate investment trust - has an immediate cash flow advantage of 8% to 12% from rental income. "This cash flow is substantially sheltered from income tax during depreciation write-off. There are a lot of variables going into the stock market." Investing directly, he adds, "is a lot less volatile." David Young, an associate at Hendricks and Partners, however, says that the upside of a REIT is that an investor can get in and out quickly, regardless of the market conditions. (Vanessa McGrady, American City Business Journals 6-21) Although approximately 5% of all 401k plans offer a REIT choice, it has been estimated that only 0.1% of all 401k plan assets are invested in REIT funds. (Ralph Block, REITWEEK 6-14) Florida typically benefits from being one of the last states to feel the effects of an economic downturn; and it is one of the first to recover. 'If you looked at all the office and industrial markets in the country, Florida's markets - especially Orlando, Tampa and South Florida - were in the top 10,' said Larry Richey, senior managing director of Cushman & Wakefieldof Florida. Like most of his peers, Richey is predicting 2002 to be 'another difficult year,' but not as bad as 2001. 'January and February were perhaps the slowest months that I can remember since the 1991 recession, but it's continuing to pick up and I think we're going to see a significantly more active and improved market,' he said. (Tampa Tribune 6-9) About $1.78 billion flowed into real-estate mutual funds in the first five months of this year, compared with inflows of $113 million in the year-ago period, according to AMG Data Services. Inflows haven't been that strong since the first five months of 1997, when they totaled $2.4 billion. Funds that invest overseas or in the stocks of home builders have been outperforming other types of real-estate mutual funds this year. "Not all real-estate funds are created equal, so look under the hood and figure out what the investment strategy of the fund is," says Phil Edwards, managing director of global fund research at S&P. For example, when the economy recovers and interest rates rise, the housing market might cool, "so the funds investing in home builders may do worse." (Ray Smith, WSJ 6-5) Real estate discussion boards can be found at Yahoo.com, Investorschat.com, Talkstox.com. and www.fool.com [which has a $30/yr fee]. (Real Estate Portfolio May-June 02) The national industrial market is more than twice as large as the office market measured by total sq. ft. (Green Street Advisors Q4-01) Home Page Previous REIT Update Top Sites
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