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Siegel sees hopeful signs that office markets nationwide are on the mend. One bit of evidence: The return of sublease space finally seems to be slowing. 'Although it is still negative overall, the negative retraction is reduced,' he said. Even better news is that corporate tenants - not just service sector businesses - seem to be shaking their 2002 deal-making paralysis. 'I remain bullish,' Siegel concluded. 'I firmly believe the prediction that at the end of the year, we'll return to somewhat of a healthy environment.'
Grubb & Ellis says the average vacancy rate jumped to 10.06% in the first quarter, from 8.89% a year earlier, a bigger jump than expected. It was the sector's highest vacancy rate since the third quarter of 1994, when it was 10.53%. Average asking rents - the rents landlords ask for as opposed to what they collect - for distribution warehouses fell to $4.43 a square foot from $4.83 a year earlier. Average asking rents for research-and-development industrial facilities fell to $11.51 a square foot from $12.17.
Bonds have an even lower correlation to the S&P: just 0.11 over the past decade. But history shows that long-term U.S. Treasury bonds provide returns that are only half those of stocks. REITs, at least in their more recent, well-managed, lower-risk incarnation, return about the same as conventional stocks.
Raymond Mathis, REIT equity analyst at S&P, says the decision to include REITs was spurred, in part, by the amount of phone calls he says S&P fielded from institutional investors who wanted to invest in REITs. Some institutions require a high S&P quality ranking on a particular stock before they will invest in it. But since REITs weren't ranked, they were off-limits to a number of institutional investors. In general, the rankings - graded on a scale of A-plus to C, with A-plus signifying the company has the strongest dividend and earnings growth -- appear on the front of S&P's stock reports, which are available to individual and institutional investors, mutual funds and financial advisers who subscribe to S&P. The rankings are calculated annually. But they can change before a year ends if there's a major dividend cut or bankruptcy in the interim. The rankings are less a predictor of future performance than a look at how companies perform over time. In February, S&P released a study showing that a portfolio of U.S. stocks with a long-term history of earnings and dividend growth outperformed the S&P 500 over a period of 17 years and significantly outperformed portfolios of stocks without as favorable a history of dividend and earnings growth. The only REITs [currently] assigned A-plus ratings are shopping-center owners Kimco and Mid-Atlantic Realty Trust.
The Crown American portfolio consists of 26 wholly owned regional malls and a 50% interest in Palmer Park Mall in Easton, Pa. With the Crown American deal as well as previously announced plans to acquire six Philadelphia-area shopping malls owned by Rouse, Pennsylvania REIT will own interests in 54 retail properties with 33.5 million square feet in 12 states. About 82% of the portfolio is in the mid-Atlantic region, where the company now will be a leading shopping-mall REIT. The merged company will have a total market capitalization of about $2.7 billion. PEI expects its first full year of combined operations will be in 2004. Pennsylvania REIT expects full-year 2003 FFO of $3.34 to $3.46 a share and full-year 2004 FFO of $4.26 to $4.38 a share.
In 2003, current projections for retail closings total 6,800 stores. Closings for 2004 are not expected to exceed the current year. Even if the retail sector were to hit bottom in 2004, it is estimated that fewer than 40,000 stores could be shuttered in this recession. This is less than 11% of the supply operating four years earlier, which hardly qualifies as a sector collapse. In the middle of all this downsizing, new supply will have expanded by another 77,000 stores. How much of this space is competitive will be determined over time. Never underestimate the power of creative destruction to prevail. It is estimated that less than 60% of the 6 billion square feet of supply on the MAX-SI Spatial Index was noncompetitive. Yet, in 2003, many of the weak credits and even weaker formats will add another 8,000 stores, or 42% of the new pipeline. According to Retail Maxim's watch list of 250-plus retailers, the negative credits are significant. REITs continue to report high occupancy levels during the recession, but how many leases support weak credits, or have been re-let to more speculative credits where stores have closed? The recession is taking on a new shape, with a whole new set of risks. In the first stage (2000-02), the broad retail sector was protected by reflationary (reflation is government monetary action that causes a reversal of deflation) monetary policies and economic stimulus that ensured low borrowing costs and robust spending. Retailers could rationalize opening stores and deferring closings. In the second stage (2003 and beyond), reflation is rapidly turning into stagflation. The current accounting crisis, falling U.S. dollar, outflow of foreign investment and rising costs have elevated the specter of inflation. Credit will not come cheap or easy. Selling real estate may be the only recourse for the retailer to remain whole.
The baby boomers, the huge demographic cohort that grew up with the mall industry, are now moving toward retirement. Their spending is expected to slow down as their income growth ends. That will pose some tough challenges for the department stores they patronize - and which remain the most important anchors at regional malls. 'Who shops at department stores these days? People 50 and over,' says Kurt Barnard, president of Barnard's Retail Consulting Group. 'Young people were brought up on specialty stores, and they avoid department stores.' Malls are suburban. The suburbs have a growth problem. Many consumers have grown weary of long commutes and lack of convenient amenities. Young professionals flock to 24/7 downtowns while empty-nester baby boomers are trading their suburban spreads for the restaurants, theaters and easy commutes of urban life. Nationally, the increase in city housing permit activity from 1999 to 2000 exceeded the average annual increase in city housing permits from 1990 to 1998 by 35%. By contrast, suburban housing permit rose 21%. From Boston to Miami to Denver to Chicago, retail development is following these new urbanists. Washington, D.C., is a good example. The district has seen a surge of retail development that reflects not only the gentrification of formerly blighted areas but also the rising affluence of the city's African American and Hispanic residents. An equally significant force shaping the mall of the future is income distribution. After almost 30 years of nearly stagnant income growth for the average American family, the great middle class, which has supported the conventional shopping center, is under stress. A decade from now, says Troy Peple, president of Chainlinks Retail Advisors, 'I don't think there's going to be a middle class. There's less today than there ever has been, and this affluence gap will continue to widen and accelerate.' The erosion of the middle class is an ominous development for mid-price retailers, including department stores. 'You'll see a continued decline unless they can recast themselves, and it's hard to compete on value,' Peple says. 'The people who are on fire are the retailers that emphasize value, specialization and convenience.' What this means to Malls of the 21st Century So 'maybe the mall of the future is going to be a stealth mall; it's going to be a mall, but one that is disguised as not being a mall,' says Gregg Pasquarelli, a Columbia University professor and co-founder of ShoP Architects. Are lifestyle centers and outdoor formats a fad or a trend? Developers have built more than 10 million square feet of lifestyle center space since 1995. According to Retail Traffic's Developers Expansion Plans survey, at least 22 more such projects will appear before 2004. According to the survey, developers will produce about 8.25 million square feet of new regional mall space in 2003 and 8 million in 2004, down from the 11.5 million delivered in 2002. Six new regional malls will open next year, compared to 11 in 2001. In the near term, nobody is questioning the viability of the enclosed regional mall. These properties continue to enjoy low vacancies, increasing rents and steady lease renewals. Productivity for enclosed malls of all sizes, of which there are 1,182 in the U.S., was pretty much unchanged in 2002 - generating annual sales of $330 per square foot, just $4 less than a year earlier, according to the International Council of Shopping Centers. But not all such malls are going to survive. The industry's less profitable malls are already struggling to reinvent themselves to capture new tenants and traffic. In a recent Wachovia Securities-sponsored conference call, members of the CB Richard Ellis Retail Services team pointed out that three distinct mall segments currently exist: Between 20% and 25% of the nation's 2,000+ malls are A quality or 'fortress malls' and are typified by sales of more than $400 per square foot. Some 40% to 45% are 'franchise malls', with sales of $300 to $400 per square foot. The remaining 30% to 40% are 'transition malls' - the ones that need help. Retailers are limiting expansion activity to only the best locations, so fortress malls are holding on,' CB retail services senior manager Bob Burke says. 'This segment is seen as the source of the greatest stability for the next 10 years.' Transition malls will likely experience a complete transformation within 10 years either into alternative retail formats such as power centers or non-retail uses, according to Burke. Many franchise malls will attempt an upscale shift in merchandise mix to attain fortress status or move downscale by bringing in more discount-store anchors and in-line tenants. How can these endangered malls be reinvented? Kurt Barnard's advice is to specialize. He believes that consumers will flock to centers that deal only in home furnishings or apparel or even footwear. If you know what you want, you'll know where to go. In fact, specialization is already happening. In the Georgetown section of Washington, D.C., the new Cady's Alley development has differentiated itself from the myriad other centers in the metro area with 130,000 square feet of retail focused mainly on furniture, accessories, floor coverings and bed and bath products. The project has drawn rave reviews - and rents of almost $60 a square foot. The trend that makes the most sense to many crystal-ballers in retail real estate is the community center idea. The most successful projects in the future will incorporate important family functions alongside retail stores - medical and dental offices, for example. Maybe a sports arena on the grounds for soccer or hockey. Anything, in short, that brings families together in a safe, secure and fun setting. That's why Henry Gruen's Southdale Center, the nation's first enclosed mall, featured a public auditorium, an ice rink and even a school. Malls and shopping centers may evolve into a combination of lifestyle-facilitation places where we can go and execute all of our needs. That would mean malls with groceries, schools, day care and farmers' markets in the parking lots. 'What you'll end up seeing in 10 years are shopping centers that are more of a hybrid - discount retailers mixed with specialty. The line has grown much funkier,' says David Kass, president of Continental Retail Development. Discounters such as Target and Kohl's may emerge as anchors. Upscale supermarkets could succeed nicely as anchors. Composite Real Estate Trend Forecast for Top U.S. Markets Source: Reis - Forecasts as of 3Q 2002 [NOTE: 'Retail' does not include malls.]
Ken Rosen, CEO of Lend Lease Rosen Real Estate Securities, believes the difficulty in analyzing the economy right now is that we have what is called a dual economy. "We don't have an economy in recovery or recession, but we have parts of the economy in deep recession, almost depression, and we have parts of the economy that are doing very well," he says. Economy.com's Mark Zandi sees a market recovery having more of a negative effect on REITs. "Ultimately, the rest of the economy is going to find its footing, and investors are going to find other places to put their money. The need for safety will appear to fade, and at least through 2005, REIT stocks will under-perform the broader market indices." David Shulman, a senior REIT analyst at Lehman Brothers, shares Zandi's viewpoint. "Lots of people say stock returns are going to be single digit and real estate is going to be double digit going forward on a long-term basis," Shulman says. "That does not make a lot of sense to me. The only way that would make sense is if there was a forecast of high inflation. If we go forward 10 years and the stock market delivers a 10% return, real estate delivers 8% and bonds deliver 6%, that is not a bad world."
Scott A. Wolstein, DDR's chairman and chief executive officer stated, "I am pleased to report continued strong earnings growth driven by positive fundamentals in our portfolio. We are particularly pleased to achieve this growth while reducing the contribution of lease termination fees, merchant building gains and other non-traditional income sources by approximately $0.06 per share of FFO as compared to the first quarter of 2002. In addition, our balance sheet continues to reflect consistent improvement and enhanced financial flexibility, which positions the Company for additional growth through 2003 and beyond." Leasing activity continues to be strong throughout the portfolio. During the first quarter of 2003, the Company executed 58 new leases aggregating approximately 305,000 square feet and 99 renewals aggregating approximately 430,000 square feet. Rental rates on new leases increased by 26.6% to $13.90 per square foot and rental rates on renewals increased by 8.6% to $11.34 per square foot. On a blended basis, rental rates for new leases and renewals increased by 11.6% to $12.28 per square foot.
FFOs were $76.6 million ($.82 on a per share basis), an increase of 52% over $50.5 million ($.57 per share) in last year's similar period. Quick Facts, Stats & Opinions Real estate may be in favor now, but 'don't delude yourself. You'll be out of favor soon enough, cautions real estate economist Peter Linneman. Three years ago, you couldn't give away a grocery-anchored strip center. Now they're priced at cap rates of 7.5 to 8.25%. Real estate is considered good now only because it's attracting capital. (Suzann Silverman, CPN 5-26) It's a good time to be a shopping center owner - especially on Long Island. The Q1 vacancy rate at the nation's neighborhood shopping centers was 6.8%, according to figures provided by REIS. That compared with 6.9% at the end of 2002 and 7.1% at the end of Q1-02. Meanwhile, average asking rents for these stores actually rose slightly to $16.79 per square foot per year, up a dime from Q1-01. The news was even better on Long Island, where strong demographics and little land for new development pushed vacancies down to half the national rate. REIS said Q1-03 vacancies stood at 3.4%, compared with 3.8% at year end and 5.7% one year earlier. The average asking rent in Nassau and Suffolk was $21.57 per square foot, up from $21.32 at year end and $20.80 one year earlier. (Newsday 5-22) A total of 8.5 million square feet of retail space was built in Houston in 2002, up 40% from the 5.1 million square feet built in 2001, according to O'Connor & Associates. The occupancy rate for Houston's retail space dipped slightly, from 88.4% in 2001 to 87% at the end of 2002. But retail construction is expected to decline this year, with the shopping center market strengthening in 2004, said Richard Zigler, director of research for O'Connor. (Ralph Bivins, Houston Chronicle 5-17) The Dallas-Fort Worth shopping center market is in the pink this year while other sectors struggle. Shopping center occupancy rates at the end of the first quarter were unchanged at 88 percent, according to a new report by Roddy Information Services. Overall retail building occupancies grew by about 800,000 square feet in the last year. And overall rental rates were up about 1.5% from Q1-02. (Steve Brown, Dallas Morning News 5-16) Although San Diego County apartment prices continue to rise, renters are having an easier time finding a place to rent, according to a study released yesterday by the San Diego County Apartment Association. The Spring 2003 Vacancy & Rental Rate Survey shows a vacancy rate of 4.5%, compared with 2.5% a year ago. The association also reported a countywide average cost of $987 per month for a two-bedroom apartment, compared with $925 a year ago. That's an increase of nearly 7%. MarketPointe Realty Advisors' survey of 872 market-rate complexes of 25 units or more found the vacancy rate had more than doubled to 4% between September and March. A year earlier, that survey found a countywide vacancy rate of 2.58%. (Emmet Pierce, San Diego Union-Tribune 5-17) Things are really looking up for Downtown Manhattan. In April, the commercial vacancy rate saw a huge improvement. According to Colliers ABR's Manhattan office market report, Downtown's Class A vacancy rate fell to 12.9% from 15.3% in March (most of Downtown's empty space is Class A). In April 2002, the Class A vacancy rate was 11.9%. The overall vacancy rate dropped from 14.9% to 13.5% - its lowest level in one year. (Therese Fitzgerald, CPN Online 5-13) REITs issued more than $4.5 billion of unsecured debt in Q1, the highest quarterly level of unsecured debt issuance since the beginning of 2001. REIT cfos were opportunistic in taking advantage of low interest rates. "Coupons were sub-five . . . that's historically unprecedented," said Ralph Rose, managing director at Bear Stearns. By comparison, REITs issued $10 billion in unsecured debt in 2002. Another $2.6 billion of REIT unsecured debt is scheduled to mature in 2003. In Q1-03, REITs raised $257 million in common stock and $308 million in preferred stock, according to NAREIT data. By comparison, REITs raised $2.5 billion in common stock in the Q1-02 and $743 billion in preferred. With REITs not trading at premiums and private firms outbidding them on acquisitions, it is more profitable to raise money through asset dispositions. (Eric Rosenbaum, Institutional Investor 5-4) Larry Raiman, director of REIT research at Credit Suisse First Boston, has done research that shows that REITs with rising dividends (specifically - those with at least 8% dividend growth and declining FFO payout ratios) have outperformed the average REIT by more than 9% annually since 1997. In 2000 alone, the 16 REITs that increased their dividends by more than 8% outperformed their brethren by nearly 13%. "A strong correlation exists between total return performance and high dividend growth," he says. "The sectors and companies that generate the highest dividend growth will continue to outperform the overall REIT industry." (Christopher Edmonds, The Street.com 7-31-01) [I just ran across this article while doing a goggle search for some research. ] Explanation of New Purchases - Part One I decided to sell HIW because it was HIW's management that said a turnaround for it could take until 2005. Suburban office properties are the first to vacate and the last to refill. HIW cuts its dividend and may not have cut it enough to keep its Cash Available for Distribution more than its pay-out in dividends. HIW breached its sell criteria. I needed to replace HIW in the office sector. I also wanted to over-weight retail, and I wanted to add an industrial sector REIT. I wanted a reason NOT to add CARS or EPR - else they were to be purchased. I also wanted a reason NOT to add a mortgage REIT for the same reason. NLY was on the buy list. I was burned on HIW by its lack of its dividend coverage ratio. I was not going to repeat that mistake. I had about $10K to spend. I spent 3 months researching the last purchases - and this time I needed to reach the buying decision in a shorter time frame because of reasons beyond what I wish to go into here. But those time constraints kept me from looking into balance sheet health and same-store NOI growth. This could lead to a reversal of some of the decisions made below. I did not consider adding to any existing holdings, because I was not beating the sector averages, thus I thought I needed to add holdings - different holdings. I did not consider CPG because I was already over-weighted in malls REITs. CPG is not an enclosed mall - but it has mall type clients. At least more so than shopping center REITs that were under consideration. I looked at adding an apartment REIT, but other than ESS - which I considered over-valued - I found none worth buying. Under-weighting the sector made sense. But it also made sense in October, and I was glad I had not done so. I was not going to add to Health Care. The outlook for Hotels still scares me. At this point in time, I do not know how much the above lack of logic (specifically concerning CPG and apartments) failed me. I also had more than $10K to invest, but limited my REIT purchases to this amount. There were (at least to me) obvious choices. Replace HIW with BXP, because I considered it best in its sector. If you want to add to retail (shopping centers), the obvious choice was KIM. If you wanted to add an industrial, add PLD. If you wanted a reason NOT to add CARS or EPR, show that it was under-performing or was over-valued. As for a reason not to add a mortgage REIT, show that they had not outperformed the RWR or ICF index over the last few years. First, the easy part. Mortgage REITs had NOT outperformed the index averages (RWR or ICF) over the past two years. But EPR and CARS had done so. Both BXP and KIM were much better than average, but were not the best in their sectors. I determined this by using 'Yahoo! Finance' graphs. So I was left with weighing past performance against present valuations and present expectations. With the last purchases, I was dependant on valuations created by other sources. Those valuations turned out to be both dated and wrong. This time around I was using valuations that were less dated, because I was creating them for myself (and the luck few who happen to wonder upon this site). The data bases I was using could be dated. But the calculations were current. They (the expectations) could still be wrong. Re-reading the expectations for the last purchases just scares me. How wrong were the FFO expectations then? So (1) I am not buying a stock, I am buying a 'story', a sector, a management team and a market. (2) I am considering valuations with an expectation that there are errors in them. (3) I am valuing past performance because that is one number that is real. And (4) FFO/Dividend coverage is real. This was what I was thinking when I went about deciding what to add to the current portfolio. Explanation Part Two - The Screening Process When it came to the Office sector, only AMV (125%), OFC (140%) and SLG (100%) had beaten BXP's (55%) 5 year performance. [These figures are estimates from reading the 'Yahoo!' graphs] If one considers ARE (75%) an office REIT, then it deserves attention in this class too. AMV is a small cap, has only one analysts covering the stock, has poor dividend coverage, had the highest Price/FFO but had the best dividend yield. A SLG purchase would overweight the portfolio with a strong presence in NYC - that being VNO's primary market. VNO's second largest presence is in DC - but for some reason I failed to count that against OFC. SLG and OFC had similar dividend coverages, yields and Price/FFO's. That left OFC with its strong Washington D.C. presence as the clear winner. OFC has a low dividend, higher than average Price/FFO, but strong dividend coverage. It was growing FFO in 03 (and SLG was growing at half OFC's rate, 9.74% vs 4.87%). And Washington's office market was the strongest in the nation and viewed to be close to recession-proof. When it came to the Industrial sector, CNT (125%) and ARE (75%) whipped PLD (48%) in 5 year total appreciation. ARE slightly beat CNT in projected FFO growth, beat CNT in Price/FFO (10.02 to 13.56), beat CNT in dividend coverage (46.95 to 56.35), and beat CNT in yield (4.68% to 4.16%). When it came to CARS (175%) vs EPR (145% 5 year appreciation), EPR had the cheaper Price/FFO (9.87 vs 12.29), and the higher yield (7.33% vs 6.24%). But EPR averaged having earnings disappointments, CARS averaged HIGH earning surprises (those stats kept at the WSJ). CARS's Price/FFO was a concern, but the yield gave me comfort. CARS had a higher analyst rating. A 6.24% yield on a stock that had more than doubled in 5 years! EPR rents heavily to only one company - a danger signal. Theaters are just coming out of a over-supply situation, which may have helped EPR's bounce. How easily could theaters become over-supplied again? Are theaters endangered by the rise in quality of home-theaters? Will the lapse in time between theater release and video release continue to shorten and will that hurt theaters in the future? I just felt more comfortable owning car lots to movie theaters. That raised the threshold at which EPR needed to outperform CARS. CARS won on the intangibles. CARS was a GARP stock with a better 'story'. When it came to the Retail sector, BFS (125%), DDR (120%), EQY (155%), PNP (175%) and UBP (125%) strongly beat KIM (98%) in 5 year appreciation. But DDR had the cheapest Price/FFO, the best dividend coverage, the best yield to dividend coverage ratio and the second highest yield. The Sell Criteria I am just giving one tangible criteria this round - Decreasing FFO expectations vs those in their sector. The best reason for selling a stock remains a change in its 'story'. As long as I can tell myself that (1) it will do better than sector average over the long run; (2) it serves a growing and profitable market; (3) its dividends will increase faster than inflation; (4) it has a management that I feel is making the right decisions; and (5) owning it helps me sleep at night - then I am holding on. For the record, HIW failed criteria 1, 2 and 5.
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