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Grocery-anchored strip centers and big-box retail centers, also called power centers, as a group had vacancies of 6.9% for the quarter, down a bit from 7% during the third quarter and up only slightly from 6.8% for the year-ago fourth quarter, Reis said. Occupied retail space in shopping centers and power centers for instance, rose by 5.8 million square feet during the fourth quarter among a total inventory of about 1.4 billion square feet in the nation's top 48 markets. Demand was positive all year, even for the first quarter of 2002, a traditionally weak quarter in the midst of a general economic slowdown. Retail real-estate forecasts call for a modest softening in an otherwise stable sector. Reis says vacancies for strip centers and power centers should rise about one percentage point to 7.9% by the end of 2004. Reis doesn't provide mall forecasts. Mr. Kirby said his firm sees the vacancy rate increasing moderately in malls from current levels, mostly because it stands at such a relatively low level. "It really has only one direction to go from here," he said.
Macerich, with 57 stores, has the biggest financial exposure, with Musicland stores making up 2.7% of the company's annual FFO, said Morgan Stanley analyst Matt Ostrower. General Growth, with 100 stores, gets 1.9% of its FFO from Musicland stores. Crown, with 8 stores, gets 1.8% of its FFO from Musicland. CBL, with 36 stores, receives 1.5% of its FFO from Musicland while Rouse, with 36 stores, gets 1.4% of FFO from these stores, Ostrower estimates. As for Trans World Entertainment (which is also closing stores) - Crown, CBL, Simon and Macerich appear to have the biggest exposure to this company's stores. Crown, with 20 stores, relies on Trans World for 6.2% of its FFO, CBL gets 2.1%, Simon 1.6% and Macerich 1.3% of its FFO, according to Ostrower.
Furthermore, new construction has remained at levels consistent with the peak in the mid- to late-1990s, which will continue to weigh on property-level performance, and delay a recovery. The nation's multifamily housing starts have been rising over the past 10 years and are now at their cyclical peak of an annualized 320,000 units. This new construction activity is twice the pace that occurred during the previous recession of the 1991-1993 period. While new construction remains at levels not supported by current demand, for the most part, REITs have shown relative restraint, limiting development to projects already planned or in process. Construction in progress to income producing assets as of June 30, 2002, was 5.4% compared with 6.5% the prior year and 7.9% at the end of 1999. The 2002 absorption rate, estimated at 216,000 units, represents a sharp drop from the 291,000 units registered in 2001 and the lowest level since consistent numbers were compiled in 1996. As a result, the apartment vacancy rate, according to Property & Portfolio Research (PPR), has risen to 7.0%, its highest level since 1992. Standard & Poor's expects the presently weak conditions to persist, with any meaningful improvement in demand and pricing power lagging into 2004. From a long-term perspective, however, all of these factors nagging the financial performance of apartment real estate are likely to reverse within the next five years. Two major age cohorts, 60-to-64 and 25-to-29, who are predominately potential apartment dwellers, are projected to grow rapidly in the next five years. The 60- to 64-year olds are quickly becoming empty nesters. Many of them are likely to opt for a different lifestyle by moving out of single-family houses into apartments. Projected Population Growth of Selected Age Cohort, 2003-2007
Despite weak fundamentals and property-level performance in the multifamily sector, there continues to be a disconnect between these weak fundamentals and the prices currently being paid for apartment assets. Demand for these assets has remained strong, resulting in aggressive pricing with cap rates ranging between 7.0% to 9.0%. As a result, many REIT owners have remained active sellers. Low interest rates and greater scrutiny of controllable costs currently support average coverage measures of 2.5x debt service and 2.1x fixed charges, which are essentially unchanged from the prior year. Given Standard & Poor's expectations for continued softness for 2003, as well as the impact from higher insurance costs, real estate taxes, and the likelihood of higher utility costs, these measures remain vulnerable to deterioration in the near to medium term. Furthermore, while REIT variable-rate debt exposure remains moderate at 20% of total debt, REITs with greater exposure to variable-rate debt could see their coverage measures come under pressure if the Federal Reserve begins tightening short-term interest rates sometime in 2003. The average funds from operations common stock payout ratio has increased to 76%, and, backing out recurring capital expenditures, the average adjusted payout ratio is roughly 90%, leaving only a modest cushion. Four apartment REITs were recently over 100% on an adjusted basis, with one rated REIT recently cutting its dividend. With conditions expected to remain challenging throughout 2003, apartment REIT management teams will have to closely manage operations with an eye towards covering dividend obligations and capital expenditures. It is expected that a handful of apartment REITs will hover near the 100% payout mark, but will avoid a dividend cut. Mitigating some of Standard & Poor's concern regarding the lower internal liquidity that this implies, is the currently strong external liquidity in multifamily assets as investments, which some REITs may reasonably use to temporarily finance a moderate dividend shortfall. But should fundamentals weaken materially from this point (without dividend policies being revisited), Standard & Poor's would expect to see a handful of multifamily REIT outlooks and/or ratings come under pressure.
Because REITs are economic laggards, same-property revenue growth across the industry is likely to continue slowing in the first half of 2003. We see a bottom forming for most property types by midyear, with recovery coming only after job growth resumes. However, many REITs will boost their income through other means. Some have raised, but not yet fully deployed, equity capital that could be used for acquisitions that could increase financial results. Others are boosting earnings by refinancing debt, enjoying substantial interest rate reductions. Many are trimming noncore holdings and unlocking capital gains in the process. Among the various major property types, retail REITs should continue to be robust performers. Relatively healthy consumer spending has kept occupancy high and allowed rent increases. We believe that the recent wave of home refinancing will keep consumer spending strong over the near-term. However, the retailers themselves have faced heightened competition, price disinflation, and rising costs, resulting in serious margin erosion. These forces have caused a number of retailer bankruptcies, and shares of REITs with exposure to tenant bankruptcies have come under pressure. Office REITs will likely experience higher vacancy rates, as unemployment levels peak and unused space comes onto the market. Although the rate of deterioration has begun to slow, excessive supply has resulted in sharply reduced asking rents. The data indicate that net absorption of office space has begun to turn positive, but developments continue to be delivered vacant. We expect that with construction pipelines emptying, the industry could reach supply/demand equilibrium by yearend. The twin forces of record single-family home sales and rising unemployment continue to negatively affect residential REITs. Home ownership is now at an all-time high, and we believe 2003 will be another strong year for home sales. REITs offering upscale apartments that cater to renters by choice, not by necessity, will be the hardest hit. Many landlords are now offering concessions of several months free rent to stimulate occupancy, cutting net effective rents drastically. Mortgage rates remain extremely attractive, and show no sign of rising. However, with higher home prices, more competitive asking rents, and an economic recovery under way, even residential REITs could find their footing in 2003. Unlike previous economic recoveries, hotel operators are unlikely to lead the way out of the doldrums this time. Although occupancy has recovered, the price has been steep reductions in average daily room rates. Corporate rates negotiated at the end of 2002 have likely locked in subpar revenue for 2003 as well. The threat of war in the Middle East could curtail travel further. As hopes for a quick recovery have dwindled, many lodging REITs have pared back their 2003 projections. At this point, Hospitality Properties Trust is the only hotel REIT remaining that continues to increase its substantial dividend instead of cutting it. Primary factors to consider in evaluating a REIT security are the stock's current dividend yield and long-term dividend growth rate. As of Jan. 8, the average REIT yield was approximately 7%. Investors should also consider the anticipated direction of interest rates, fundamentals for the dominant property type of the trust's holdings, and net asset value per share. As REITs slog through this trough in fundamentals, we caution investors to choose their stocks carefully. Hospitality Properties Trust Raymond Mathis, BusinessWeek 1-10 Standard & Poor's remains bullish on REITs such as Hospitality Properties and Chelsea Property Group, despite news of the dividend tax cut exclusion. Hospitality Properties acquires, owns, and leases hotel properties throughout the U.S. All of its hotels are operated by major-brand owners - such as Marriot, Wyndham, and AmeriSuites - under long-term triple net leases. This means tenants are required to pay rent regardless of industry fluctuations, as well as pay for expenses such as taxes, insurance, and utilities. The trust has raised substantial equity capital intended for acquisitions. However, it has been very cautious on this front due to relatively high property prices. We think Hospitality's recent payoff of its line of credit may signal it's getting close to making an acquisition. The stock recently offered a secure 8.3% yield, substantially higher than the REIT industry average, and another dividend increase is likely over the next 6 to 12 months. Only 74% of Hospitality's 2002 dividend was taxable as ordinary income, and the remainder was tax-free [or tax-deffered] at both the corporate and individual levels.
Steve Sakwa, a Merrill Lynch analyst, said a worst-case scenario would have the REIT index falling as much as about 9%. He says REIT share prices would have to fall by about that amount to raise their dividend yields enough to maintain their relative advantage over the yields of S&P 500 stocks, assuming those dividends are tax-free. "It's reasonable to think about," he says. "But then you've got to assess probabilities. This is a political hot potato." The president's plan might also have an unintended side effect: giving REITs incentive to rethink whether they want to be REITs at all. Mr. Kirby says that if REITs lose their status as the only major industry whose earnings are taxed at a single level, some REITs might choose to abandon the corporate exemption in favor of the personal one. For a few REITs, this could have the effect of boosting investors' after-tax returns, Mr. Kirby says. A final wild card is REIT investors that aren't so tax-sensitive, such as pension funds and retirement accounts, which wouldn't benefit from the tax-law change and would tend to stick with REITs' higher yields. Mr. Litt estimates about half the amount invested in REITs could fall into this category. A spokesman for the NAREIT said [Bush's dividend proposal] contained no surprises. "We understand the president's rationale, and we're generally supportive of the president's aims," a spokesman for the trade group said. "Anything that gets the economy going will be beneficial to real-estate companies and for REITs." Characteristics of S&P's Rated Industrial REITs Standard & Poor's 1-9-2003
Demand for office space in the quarter turned positive for the first time since the first quarter of 2001, nudging up 1.3 million square feet, according to a survey of the country's top 50 markets by Reis. The amount of positive demand is minuscule compared with the approximately 530 million square feet of space that is currently vacant, according to Reis. But it ends a string of seven quarters, starting in the first quarter of 2001, in which tenants put more space back on the sublease market than they rented. A big worry for landlords right now is rents. The average rent nationally slumped 1.1% in the fourth quarter, to $21.79 per square foot per year, including build-out costs and other concessions offered to tenants, Reis says. All told, rents dropped 7.7% in the year and are 16% off their peaks of $25.74 at the end of 2000. Furthermore, with the average office lease term at about six years, many analysts are worried that leases coming due in 2003-2006 will be signed at lower rates than those that are in place. Office Update - L. A. Roger Vincent, LA Times 1-9 Downtown L.A.'s vacancy rate reached 19.6% at the end of 2002, up from 16.9% at the end of 2001, a report by Cushman & Wakefield found. Los Angeles County lost 17,500 jobs between November 2001 and November 2002, according to the latest statistics available from the state Employment Development Department. Office vacancies in Los Angeles County rose to 18.8% in 2002 from 16.8% in 2001. More sublease space and 2.2 million square feet of new office space were behind the increase, the report said. About 1.6 million square feet of that still is vacant. Orange County fared the best among the region's major markets; its vacancy rate was virtually unchanged last year at 17.5%, compared with 17.4% a year ago, the study found. Rents, however, have fallen 12.9% since the first quarter of 2001. About 14.8% of all office space in the U.S. was unoccupied at the end of December, noted Maria Sicola, senior managing director of research at Cushman. The last time vacancies were this high was at the end of 1996, when the rate also was 14.8%. The amount of excess space offered by tenants for sublease fell nationwide to 40 million square feet, the second straight drop, and a decrease from a peak of 43 million square feet in mid-2002. The pace of leasing nationwide accelerated in the quarter, with 20 million square feet of space leased, up from 18 million in the previous quarter, according to the study. Office Update - Houston Ralph Bivins, Houston Chronicle 1-5 Houston's downtown Class A office vacancy has risen from 2% to 10% over the last year or so, and several experts are projecting the vacancy rate will rise to near 20% after the opening of two new downtown towers in 2003. The two new downtown skyscrapers - the 800,000-square-foot Reliant Energy Plaza and 700,000-square-foot Calpine Center - are partially leased, but they will still bring a considerable amount of new vacant space onto the market when they open. Enron's new 1.2 million-square-foot office tower sits vacant in downtown. Enron's demise and shrinkage by other businesses have pushed Houston's overall office vacancy rate to 16.9%, up 3.1% from a year earlier, according to the Grubb & Ellis real estate firm. [From Bivens on 1-12: Houston's overall office vacancy rate is less than 14%, according to Trione & Gordon.] But even though the vacancy rate has gone up, it is still better than other major Texas cities. The Dallas-Fort Worth area has a vacancy rate of 24.2%, Austin is at 22.5% and San Antonio is at 19.7%, Grubb & Ellis said. Office Update - Dallas Steve Brown, Dallas Morning News 1-10 If you just consider the first-class buildings - the type companies are leasing - downtown has a 10.7% vacancy rate. That compares with a class A office vacancy in the suburbs of 21.4%, according to Cushman & Wakefield. And while the suburbs lost almost 50,000 square feet of first-class office tenants in 2002, downtown gained 72,309 square feet of tenants. That trails the almost 1.3 million square feet of total net leasing the central business district had a few years ago. But it beats the heck out of the declines. Why is downtown doing so well? It's because downtown Dallas is the capital of the area's "old economy" Ä lawyers, accountants, utilities, service companies and others that didn't get caught up in the recent high-tech boom. Downtown's strength in this down market comes from its past, not the new economy companies that filled millions of square feet in the suburbs that have now gone begging. Office Update - NYC Janent Morrissey, Dow Jones Newswires 1-15 Executives from some of the nation's largest real estate investment trusts painted a gloomy outlook for the New York office market over the next year. Vornado Realty (VNO) President Michael Fascitelli said he saw "little activity" in the NYC office market in 2002. He said the number of tenants renewing leases dipped and occupancy declined.Fascitelli doesn't see the situation getting much better in 2003. Sublease space continues to be the culprit. SL Green Realty (SLG), which focuses on B-type office properties in midtown Manhattan, enjoyed good leasing activity and stable occupancy in 2002. However, the leasing activity and 97% year-end occupancy rate came at a price: Rents fell 10% to 20% in 2002. Brookfield Properties (BPO) holds three million square feet of class A office space in midtown Manhattan and 10 million square feet in downtown. Brookfield President and Chief Executive Ric Clark said tax breaks and other government incentives have been helping to lure people to downtown. And he believes the worst is over for this area. He noted that the vacancy rate downtown was 13.2% at the end of the fourth quarter, which is a 20-basis point improvement from the third quarter. However, the rate is still a far cry from the 9.5% rate in 2001 and 3.6% vacancy rate in 2000. Over in New Jersey, where Mack-Cali Realty (CLI) has big holdings, the market along the waterfront has held up fairly well, said Chief Executive Mitch Hersh. Occupancy in Mack-Cali's portfolio has remained above 92%, he said. However, he predicts his company could lose 100 basis points in occupancy in 2003. Hersh predicts the market will remain difficult through 2003 and early 2004. From Eric Herman, NY Daily News 1-16 The [tax] value of New York office buildings jumped 6% under new assessments by the city's Department of Finance -- meaning even bigger tax bills for owners and tenants. The higher assessments come on the heels of a 19.2% hike in the tax rate for buildings, which combined will mean hefty tax increases for most landlords. Passed along to many tenants, the increases will translate into higher rents and have already chipped away at the value of some properties. Higher taxes, along with rising insurance costs, mean commercial tenants could see rents rise $ 3 to $ 5 per square foot beginning this month, the Real Estate Board of New York estimates. In a typical lease, tenants pay for any increase in taxes on their office space. At a time when profits are being squeezed, higher real estate costs could pressure companies to cut costs, including layoffs. As much as the assessment increase could hurt owners, its impact pales in comparison with the new tax rate, real estate sources said. Those increases have already brought the city's building values down 3% to 4%, said Finance commissioner Martha Stark. From Therese Fitzgerald, CPN Online 2-4 According to Julien J. Studley Inc., the average asking price for Class A space in Midtown dropped from $71.46 at the beginning of 2002 to $60.96 in the fourth quarter. Downtown rents are always considerably less than Midtown, and according to Studley, now Class A asking rents have dropped from $52.02 per square foot at the beginning of 2002 to $44.95 at the end of last year. In addition to achieving rent reductions of 10 to 30 percent, tenants signing new direct leases or renewing their leases benefit from a bevy of government incentives, further reducing their operating costs. But here's some good news for New York City landlords: Last week, New Jersey rescinded its Business Employment Incentive Program due to budgetary woes. During the last decade, BEIP helped make operating a business in New Jersey even cheaper and helped lure a number of New York City tenants across the river. Office Update - Boston Bill Archambeault, Boston Business Journal 1-10 For the last two years, Boston's commercial real estate industry has been hammered by a net loss of leased space, creating a losing streak for landlords believed to be a modern-day record and one that some fear will extend through 2003. Through 2001 and 2002, Boston's office market has shown negative net absorption in seven out of eight quarters, while the suburban market has withered under eight straight quarters of negative net absorption, according to Spaulding and Slye LLC. In 2001 Boston showed 1.9 million square feet of negative absorption while 2002 wrapped up with 1.1 million square feet on the wrong side of the ledger. In the suburbs, 2001 ended with 5.6 million square feet of negative absorption and 2002 closed out with 2.3 million square feet in the minus column. The Boston suburban markets, with a total of 76.8 million square feet of office space overall, ended Q4-02 with 12.3 million square feet of direct space vacant and a total of 20.7 million square feet available either directly or through sublease. That's an availability rate of 27%. "The first half of 2003 is going to be very important for the psychology for the balance of '03 and '04 looking forward," said William Barrack, a principal at Spaulding and Slye. Negative space absorption "affects expectations, both on the landlords' side and on the tenants' side. A lot of this business is momentum, and if the momentum is negative, it's going to take longer to pull out of it. Anxiety creates indecision in the real estate world." Office Update - Seattle J. Martin McOmber, Seattle Times 1-19 Office-vacancy rates appear to have peaked, but not before reaching decadelong highs. In hard-hit downtown Bellevue, more than a quarter of office space is empty. That's not expected to change much this year, mostly because demand for space will not return until companies start hiring. The overall vacancy rate for the Puget Sound region could drop about half a point to 15.7 percent, according to Cushman & Wakefield. About 1 million square feet of office space is expected to be completed this year, even less in 2004, according to Cushman & Wakefield. That compares with 4.2 million in 2000 and is the lowest amount in the past five years.
Apartment rents took a bigger drop a year ago, falling 2.7% in the fourth quarter of 2001. But after sliding 1.8% in the first quarter of 2002, rents began climbing. October through January are typically slow months for leasing activity, but what makes the fourth quarters of 2001 and 2002 stand out is that rents actually fell, as opposed to growing slower. The vacancy rates for apartments, currently estimated at 6.1% nationally, have been rising since the fourth quarter of 2000, when it averaged just 3%, according to Reis. Apartment Update - D. C. Neil Irwin, Washington Post 1-6 In a typical year, about a quarter of the residents in the Blair apartments in Silver Spring move out. But in the past year, even as rents on some apartments dropped from $1,270 a month to $1,050, the turnover rate shot to 40% in the 1,300-unit complex. The major reason is that longtime renters are buying homes in record numbers, Tower Cos. marketing director Carla Folsom said. Developers have more than 25,000 units of rental housing in the construction pipeline, according to research firm Delta Associates. Renters absorbed 5,700 new units in 2002, Delta said. Delta Associates found that the region's apartment vacancy rate of 2.8% is lower than any major city, though considerably higher than the 0.8% rate at the end of 2000. AvalonBay, an Alexandria-based REIT that owns apartment buildings in the Washington area and 10 other major market, said in its 2003 forecast released last month that revenue from its properties would decrease by 2% to 5% for the year, reflecting in part the company's skepticism of job-growth predictions. AvalonBay also said its operating expenses are to increase 3% to 5%, mainly because of higher insurance premiums and property taxes. The company plans to reduce development by 50% for the year, and sell as much as $350 million worth of properties. The outlook for AvalonBay applies to its entire portfolio, not just its Washington area properties. Apartment Update - Houston Ralph Bivins, Houston Chronicle 1-5 The Houston apartment occupancy rate has hovered near 93% for the last three years. Apartment occupancy for the Houston area was 93.2% in the third quarter, down from 93.5% a year earlier, according to O'Connor & Associates. The average monthly apartment rent was 76 cents per square foot in the third quarter, up from an average of 73 cents per square foot a year earlier, O'Connor said. Grubb & Ellis is predicting that rents will be stable in 2003.
Low interest rates and flight from more-turbulent sectors drove transactions in commercial real estate in the U.S. last year up to an estimated $90 billion, up 20% from 2001, says the report, citing data from Real Capital Analytics. Despite rising vacancy rates and falling rents, the average price for office buildings in central business districts jumped 43% to $228 a square foot in the fourth quarter, from $160 in the same period a year earlier, according to the Real Capital Analytics data. The average price for malls more than doubled, to $123 a square foot from $57. The average price of a high-rise apartment property increased about 70% to $169,000 per unit, from just under $100,000 a year earlier. The average for so-called garden apartments slipped 1.2% to $64,032 from $64,795. Prices for industrial properties fell 7.1% to $39 a square foot on average from $42.
Modern REITs are a product of the real-estate debacle of the late 1980s and early 1990s that left many debt-ridden developers dependent on the public equity markets for cash. Trouble was, they already had taken huge depreciation expenses on their property, and selling a stake to the public in a traditional initial public offering would trigger capital-gains tax problems. So, they turned to the "UPREIT," an ungainly two-tiered creation in which the public REIT buys a stake in an "operating partnership" that actually owns the properties. The founders typically keep partnership "units," and a smaller amount of common shares. About half of all 176 publicly traded REITs are UPREITs, according to NAREIT. Those include some of the industry's biggest names: office landlord Boston Properties, mall-owner General Growth Properties, and hotelier Host Marriott Corp. Though the founders' "units" have no formal voting power, most executives nevertheless have found ways to keep both the tax break and effective control. Take Simon Property. In court papers and elsewhere, Simon has attacked Taubman Centers for issuing special preferred shares during a 1998 restructuring that gave the Taubman family voting rights equivalent to 31% of the outstanding common shares. But, it turns out, the Simon family has unique powers of its own. During its 1993 IPO, the Simon family was issued its own special shares. Like many REITs, Simon Property doesn't fully control its properties. Instead, it is a majority owner, with the founding family, of Simon Property LP.Under an agreement with the REIT, "the consent of the Simons," is required to undertake "major decisions," including dissolution of the partnership. People on the Simon side say Simon Property disclosed the founders' rights during its IPO, while Taubman Centers changed its arrangement without a shareholder vote during a 1998 restructuring. A person on Taubman Centers' side says the Taubman family's control is commensurate with its economic stake in the company, while the Simon family effectively controls the company while owning only 16% of the shares and units. Simon's focus on Taubman's voting control "opens up a Pandora's box" for REIT governance in general, says Lesia Bates Moss, a senior vice president at Moody's Investors Service. For instance, investors may not be aware that unit holders, who often are directors and officers, frequently have lower tax bases than shareholders in properties they jointly own with the REIT and may have less incentive to sell either some buildings or the whole company. David Shulman, a Lehman Brothers analyst, refers to the conflict as the industry's "original sin." More Issues with SPG and Taubman Ray Smith, WSJ 9-25 The National Association of Real Estate Investment Trusts' guidelines say companies should include nonrecurring charges when calculating their funds from operations. Mike Kirby, a principal at Green Street Advisors, says 30% of the 63 REITs his firm follows used definitions of funds from operations in the first half of this year that didn't conform with the guidelines. On average, funds from operations in the first half for the 63 REITs were 4% higher than they would have been if all the companies had followed the strict Nareit definition. [Some of the worst offenders mentioned in the article: mall REITs SPG, Taubman, MAC and RSE - for their write-offs in MerchantWired LLC.] Quick Facts, Stats & Opinions Sublease Space Sublease space accounts for roughly 25% of all office space being offered for leasing in central business districts nationally, compared with only 9% in 1996, the last time that overall vacancy rates were at the current level [14.8%] according to the real estate services firm Cushman & Wakefield. Brokers and landlords said that companies had been encouraged to rent far more space than they could use. Wall Street demanded evidence of fast growth, and cities offered tax incentives to companies willing to expand or relocate. Now that those companies have laid off workers or canceled expansion plans, that space is sitting empty. Corporations have several incentives to withhold unused space from subleasing markets, including avoiding competing with themselves. Also, accounting rules require corporations to write down the space as a loss on their balance sheets in the year when it is declared surplus. Much of the sublease space on the market now is new or recently refurbished by primary tenants on long-term leases, but it is still being offered at discounts up to 45% off the market rate, said Bruce Mosler of Cushman & Wakefield. (Michael Brick, NY Times 1-29) Too Much Retail Space The United States has roughly 20 square feet of retail space for each person, about twice as much as Europe, said Gregg Logan, managing director of real estate consulting company Robert Charles Lesser & Co. Perhaps Americans love to shop more than consumers across the sea. But most experts say there is simply too much space. And still more is proposed. (Michael Kanell and Renee Degross, AJC 1-19) Foreign Investors in Real Estate Survey Despite the Bay Area's severely stunted economy, San Francisco apartments, offices and other commercial buildings continue to be highly sought by foreign investors, according to a study made public Wednesday. San Francisco tied as the world's seventh most-desirable place for commercial building purchases, according to a survey by the Association of Foreign Investors in Real Estate of 72 pension funds and other major investors based outside the United States. Washington, D.C., ranked first in the survey, followed by London, Paris, New York, Milan and Chicago, with San Francisco and Los Angeles sharing the seventh spot. (Steve Johnson, San Jose Mercury News 1-16) Inflation Protection The prospect for stronger growth has hit high-quality bonds hard and will continue to do so. Income investors must protect themselves with investments that offer growing income, such as REITs. (Stephen Leeb, Personal Finance via Washington Post 1-5) DC Office Update You can have expansion in government contractors with a lag before it affects the real estate market. They're just revving up again, and hiring employees, getting security clearances, winning contracts, that all takes time. That lag could continue for part of '03, certainly. (Mary Petersen, VP of Cassidy & Pinkard and veteran researcher of DC commercial real estate, Washington Post 12-31 ) Are Office Buildings Next Bubble? Mary Petersen, Cassidy & Pinkard: "If you're making 7% on a stabilized real estate asset tossing off cash, that looks great compared to stocks. And interest rates are very low. So current prices might make sense if you're a long-term holder." Jay Olshonsky, of broker CB Richard Ellis: "I think prices will maintain themselves. If you're a pension fund right now, buying an office building that's fully leased looks awfully good compared with your alternatives." (Neil Irwin, Washington Post 12-31) Timeless REIT Research [From the paper:] Research by Hemel, Sakwa, and Bhattacharjee (1995) showed that REITs have a lower correlation with interest rates than the S&P 500 index has with interest rates. This is an important finding in that it casts doubts on the argument that REITs behave more closely with bonds than with stocks. Thus far, the evidence points to the fact the REITs are highly correlated with small capitalization indices such as the Wilshire Small Value index and the high-yield corporate bond index. Given the existence of the small-firm effect in which small-firms earn abnormal returns during the month of January, it seems logical to examine REIT returns in order to determine if there is a January effect in public real estate securities. [After examining the data, Sander concludes . .] The returns in January for the REITs are clearly larger than the other months indicating that there is a January effect in REIT returns. Curiously, the average return in January is higher than average for the Wilshire Small Value index; however, the month of August has a comparable return to January. In addition, there seems to be a January effect for the high-yield corporate bonds. Other articles of interest mentioned in the paper: Chen, K.C. and Tzang, D.T., 1988, 'Interest-rate Sensitivity of Real Estate Investment Trusts', Journal of Real Estate Research. Hemel, E.S. Sakwa, and R. Bhattacharjee, 1995, 'Interest Rate Sensitivity of REITs: Myth and Reality', Morgan Stanley: U.S. Investment Research Paper] [From the paper:] Recent research has begun to empirically address these issues. Ambrose, Ehrlich, Hughes and Wachter [in 'REIT Economies of Scale: Fact or Fiction?' Journal of Real Estate Finance and Economics, 2000] study the economies of scale for the REIT industry in the early 1990s. The authors find no size-economies or significant benefits for REITs in image branding and geographic specialization. On the contrary, Bers and Springer (1997, 1998) directly test the scale economies of REITs In the 1997 article, [Economics-of-Scale for Real Estate Investment Trusts, Journal of Real Estate Research] they investigated five categories of cost sources: general and administrative expenses, management fees, operating expenses, interest expense and interest expense as a percentage of total liabilities. Using REIT data from 1992 through 1996, they found that overall economies of scale exist for all afore-mentioned cost figures except interest expense. General and administrative expenses and management fees demonstrate the largest economies of scale; operating expenses show only a modest effect and interest expense shows diseconomies of scale. In their 1998 article, [Sources of Scale Economies for REITs, Real Estate Finance, Winter 1998] they focus on investigating the differences in the scale economy in the REIT industry. The authors conclude that externally managed, low-leveraged and well diversified REITs enjoy higher economies of scale. Mortgage REITs benefit more than equity REITs, while industrial property focused REITs do better than other equity REITs. [In the end, Yang uses math and 'modelling' arguments to state that the data . .] indicates a scale-economy effect. Other articles of interest mentioned in the paper: K. Wang, J. Erickson and S. H. Chan, Does the REIT Stock Market Resemble the General Stock Market?, Journal of Real Estate Research, 1995. J. J. Vogel Jr., Why the New Conventional Wisdom about REITs is Wrong, Real Estate Finance, Summer 1997. D. R. Capozza and S. Lee, Property Types, Size and REIT Value, Journal of Real Estate Research, 1995. Existing Research From a study of REIT market microstructure, Wang, Erickson, Gau and Chan [Wang, K., J. Erickson, G. Gau and S. H. Chan, Market Micro-structure and Real Estate Returns, Working paper, California State University-Fullerton, 1992] postulate that the relationship of REIT returns and market attention actually have an indirect relationship. Their findings conclude that shares of REITs tend to have small turnover ratios, lower institutional investor participation and a smaller following among security analysts compared to other types of traditional stocks. Also, it is suggested by their research that REITs that are followed more closely tend to perform better than those REITs that are relatively obscure. This would suggest that the more scrutinized REITs might tend to be more efficiently priced. A further study by Goebel and Ma [Goebel, P. R. and C. K. Ma, Stock Returns and Business Performance in REITs, Working paper, Texas Tech University, 1993] dealt with the perception that REITs trade at discounts from their net asset values and thereby suggest relative price inefficiencies. The authors perform a cointegration analyses that confirms a long-term, equilibrium relationship between REIT returns and their underlying fundamental value. Specifically, the authors further demonstrate that REITs, in this study, traded at approximately 77% of net asset values. Suggesting that there may be price inefficiencies in play at least for the given time period of the study (1972-1992). In a more recent study by Hun and Liang [Hun, J. and Y. Liang, The Historical Performance of Real Estate Investment Trusts, Journal of Real Estate Research, 1995], the authors examine the long-term (1970-1993) performance of REITs and investigate the stability of REIT return performance over time. Their results indicate that the performance of REIT portfolios was consistent with the security market line for the long-term period. Thereby suggesting that REITs are efficiently priced in the long run. Nelling and Gyourko [Nelling, E. and J. Gyourko, The Predictability of Equity REIT Returns, Journal of Real Estate Research, 1998] examined the predictability of monthly returns on REITs over the period 1975-1995 and compare that predictability with that for small and mid-cap firms. Using a time series approach, evidence is found that monthly REIT returns are predictable based on past performance. This would suggest that the REIT market is inefficient. However, the authors are quick to point out that the predictability is not substantial enough to cover typical transaction costs, so that there is no evidence of unexploited arbitrage opportunities. The Data: (They did a runs test and an autocorrelation test on the data.) The runs test was performed using the monthly and daily price data. The runs test examines a series of price changes, and designates each change as positive (+), negative (-) or no change (0). A possible result of the test might be: + + + - - - - 0 0 + + + + - - -, which would represent five 'runs'. A run occurs when consecutive positive or consecutive negative price changes occur more than once. When the price changes to a different sign, the run is completed and a new run is started. The expected number of runs in a random series is the equivalent of E =1/3(2n - 1). Where E is the expected number of runs, and n is the number of observations. If there are too many or too few runs in the price series, then the series is not a random series. Too few runs may infer that security price changes respond rather slowly with regard to the infusion of new information in the market, whereas, too many runs may indicate that prices over adjust when new information is made available to investors. The autocorrelation test determines if the price change on day t is correlated with the price change on day t-1 , t-2 , t-3 , etc. (The runs test suggested an inefficient market for REITs) Of all EREITs [Equity REITs] tested (by autocorrelation), 48% demonstrated price dependency with regard to their own price on the prior day. Additionally, 35% of the EREITs tested indicated a two-day price dependency. Findings of their research: The results of both daily and monthly tests would suggest a degree of inefficiency in the EREIT market, at least for the time period examined [November 2, 1997 through February 1999]. This can certainly be claimed in the short-term (one- and two-day price dependencies). One possible explanation for this phenomenon is that investors may respond slowly to new market information or information is slowly and inefficiently spread throughout the marketplace allowing only a small portion of the investment community to benefit from newly arriving information. Other plausible explanations for this phenomenon may be related to the characteristics of real estate assets and markets. For example, because of the predictable cash flows from leases, REIT pricing is more bond-like in nature and thus more serially correlated. In addition, the REIT market is very small and thinly traded, thus market makers may have an influence on prices. In either case, at least for the period examined here, there is a demonstrated degree of inefficiency in the EREIT market. Existing research indicates that other high-dividend-yield stocks, such as utilities, are sensitive to interest-rate changes [Sweeney, R. J. and A. D. Warga, The Pricing of Interest Rate Risk: Evidence from the Stock Market, Journal of Finance, 1986]. Consequently, REITs may also possess a high degree of sensitivity to interest-rate fluctuations (Mengden, 1988); (Hartzell, Shulman, Langetieg and Liebowitz, 1987). Chen and Tzang [Chen, K. C. and D. T. Tzang, Interest-Rate Sensitivity of Real Estate Investment Trusts, Journal of Real Estate Research, 1988] addressed the issue of whether REITs are sensitive to changes in short-term and long-term interest rates for the period 1973-1985. REITs were found to be interest-rate sensitive and the sources and magnitude of interest-rate sensitivity were found to be different for equity versus mortgage REITs. Recently, Chan, Hendershott and Sanders [Chan, K. C., P. H. Hendershott and A. B. Sanders, Risk and Return on Real Estate: Evidence from Equity REITs, AREUEA Journal, 1990] found that three factors, in addition to the percentage change in the discount on closed-end stock funds, consistently drive equity REIT returns. The three factors are: unexpected inflation, changes in risk, and the term structure of interest rates (which I take to mean the yield curve). Glascock [Glascock, J. L., Market Conditions, Risk, and Real Estate Portfolio Returns: Some Empirical Evidence, Journal of Real Estate Finance and Economics, 1991] examined the return behavior of a portfolio of publicly traded real estate firms including a subset of REITs. He found that the beta of these firms shifted procyclically. Khoo, Hartzell and Hoesli [Khoo, T., D. Hartzell and M. Hoesli, An Investigation of the Change in Real Estate Investment Trust Betas, Summer 1993] found that betas on equity REITs underwent a structural shift in the past twenty years. They showed that this was the result of the lower variability of equity REIT returns and argued that the decrease in the standard deviation of equity REITs could be attributed to the increasing levels of information about equity REITs. Findings of their research: Substantial evidence regarding the stability of risk components for REIT securities over time has been developed. Using all tax-qualified REITs listed on the NYSE, the ASE and the NASDAQ, four equally weighted REIT portfolios were constructed: an all-REIT portfolio, an equity REIT portfolio, a hybrid REIT portfolio, and a mortgage REIT portfolio. Significant return-generating regimes were found during the 1973-1989 period for all four portfolios. The systematic risk for equity REITs was relatively stable. The risk components for mortgage REITs varied considerably more than those for equity REITs over the sample period. The market risk and the interest-rate risk of REITs, especially of mortgage REITs, were much larger in the 1970s than in the 1980s. All four portfolios experienced significant shifts in their return-generating processes. Over the sample period of 1973-1989, the market betas of the four tested portfolios were smaller than 1, indicating that the average market risk of REITs is below market average. Over the sample period, mortgage REITs have the highest market risk (.77) and equity REITs have the least market risk (.54). The mortgage REIT portfolio has the highest interest-rate beta and residual risk while the equity REIT portfolio has the lowest interest-rate beta and residual risk. The equity REIT portfolio also has an insignificant interest-rate beta. In short, mortgage REITs are considerably riskier than equity REITs in terms of systematic risk (market beta and interest-rate beta) and unsystematic risk (residual risk). The average market risk for equity REITs was .58 before 1983 and .45 after 1983. The market risk for hybrid REITs declined first (from .97 to .28) and then increased recently (from .28 to .57). Mortgage REITs experienced the most reduction in market risk during the seventeen years concerned, dropping from 1.08 to .34. [An explanation for the decrease in mortgage REIT beta's .. ] When fixed-rate mortgages (FRM) were the dominant mortgage form, mortgage REITs had to hold primarily FRMs with long durations. When adjustable-rate mortgages became a popular alternative, mortgage REITs had the choice of holding mortgages with much shorter durations. This and the development of mortgage securitization may have contributed to the reduction of interest-rate sensitivity for mortgage REITs in later years. Home Page Previous REIT Update Top Sites
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