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Companies that own apartments, hotels and warehouses made fewer purchases than their private counterparts. The decline in those areas is a trend that has been playing out for the past three years and appears to be continuing this year. The one bright spot was the retail sector, which was boosted by very large acquisitions and an initial public offering. Public ownership of apartments fell 0.1 percentage point to 7.8%; warehouses fell 0.7 percentage point to 8.6%; hotels dropped the most, 1.6 percentage points, to 14.6%. Ownership of office properties remained flat at 7.6%. Public real-estate companies increased ownership in malls by 2.5 percentage points to 36.3%. Ownership in non-mall retail was up 0.5 percentage point to 12.9%. Private firms made up 46% of commercial real-estate buyers in 2002, while REITs made up 26%, according to Real Capital Analytics. So far this year, REITs have made up 19% of the buyers of commercial properties, while private firms have made up 58%. REITs have been selling assets and using the proceeds for other purposes, such as to pay down debt. "In most environments, selling properties and [using the proceeds] to repay debt would dilute earnings," says Mike Kirby, a principal with Green Street Advisors. But, he adds, "if [the REIT has] earnings growth from some other sources, it can wash that out and have it not be too detrimental."
In the largest deal last quarter, a German-financed real estate fund, Jamestown, paid $297 million for 1745 Broadway, near 56th Street, a new Midtown building with 645,000 square feet of offices that are fully leased for 15 years to the publishing company Random House. Earlier this month, Commercial Net Lease Realty acquired WorldCom's headquarters in Arlington, Va., in a bankruptcy auction. The purchase price was more than $142 million. The federal Transportation Security Administration will lease all of the buildings' 500,000 square feet. And many more single-tenant properties with long-term leases are waiting to be tapped, said Mr. Ralston, whose company owns $1 billion in property. "This is possibly the largest undiscovered niche in real estate today," he said. But more players are entering the field, many of them offshoots of established real estate companies. Among the newest entries are Crown Capital Partners, a $425 million fund to acquire industrial properties in the United States. Some REIT's focus on specific segments of the single-tenant market - from movie megaplexes (Entertainment Properties Trust), to automobile dealerships (Capital Automotive) and even to prisons leased to government correctional departments and private operators (Correctional Properties Trust). A new REIT, American Financial Realty Trust, buys real estate portfolios from financial institutions, including bank branches. These days, the busiest buyer of single-tenant properties is Wells REIT. Wells, a fast-growing public REIT whose shares are not traded on any exchange but are sold through securities brokers, bought $1.4 billion of office and industrial properties last year, about three-quarters of them leased to a single blue-chip tenants. "A lot of other companies start with the real estate first," David Steinwedell, CIO of Wells, said. "They fall in love with the real estate and hope that works." For U.S. Restaurant Properties, a REIT trust that specializes in fast-food and family restaurants, the brand name, the historical performance of the location and the intrinsic value "are better predictors of the value of the asset" than the franchisee's creditworthiness, CEO Harry Davis said. "We're talking about a 20-to-40-year relationship," he said. "It's very difficult to predict what's going to happen to a company financially." Few people expect the single-tenant boom to maintain its current intensity as interest rates rise. T. Wilson Eglin, the chief executive of Lexington Corporate Properties Trust, said the uncertainty was putting more properties on the market. "Our acquisition pipeline has gotten much more active in the last few weeks," he said.
The only sector where investors have seen returns that have met or exceeded their expectations in the past year has been retail assets, RERC notes. Power centers returned 16.63% in total returns while regional malls posted a 12.02% yield, according to the companyÌs research. Neighborhood community centers also were in double digits at 11.43%. Now, investors are looking for an 11% return on power centers and 10.6% on other retail properties, RERC says. Investors are willing to accept going-in capitalization rates averaging 9%, according to RERC, with multifamily rental properties (7.8%) and hotels (11%) again serving as book-ends. Those figures are 10 to 30 basis points below the first-quarter numbers, the company reports. Required internal rate of returns for office properties have fallen, to 10.7% for assets in central business districts to 11.3% for those in the suburbs. Investors are looking for a 10.4% pre-tax yield on warehouse properties and 11.5% for research and development assets.
Annaly, which owns $14.7 billion in mortgage-backed securities issued by Fannie Mae, Freddie Mac and other issuers with implied or explicit government backing, keeps two-thirds of its portfolio in adjustable or floating-rate assets, which will benefit if the economy continues to pick up steam, longer-term interest rates keep rising - and short-term rates remain stable, as generally expected. "A positive-sloping yield curve is a boon to mortgage REITs - period," says Ian Goltra, director of research for Kensington Investment Group. Mortgage REITs also are grappling with the aftereffects of the recent refinancing boom that accompanied the steep drop in interest rates beginning in early 2001. Annaly, among others, bought mortgage-backed securities at a premium to face value, expecting to amortize the cost of the premiums over time as the interest and principal rolled in. But the frenzied refinancing led to record-high mortgage prepayments, which caused Annaly to write off the value of the premiums sooner than expected. In the first half, the company booked $106 million in amortization, about what it did in all of 2002. Michael Hughes, a Merrill Lynch specialty-finance analyst, adds: "Oddly, where rates are going is very positive for Annaly - except for this quarter." So far this year, through Wednesday, mortgage REITs have posted an average total return - stock price plus dividends - of 27.98%, after returning an eye-popping 31% during 2002. That far outpaces the more numerous and larger property-owning equity REITs, which have returned 18.2% this year and 5% last year, according NAREIT.
A major factor in the market's strength is the continued boom in the housing market, which has been fueled by low interest rates. Housing drives retail, and this year is expected to be one of the three best on record for home sales in the Metroplex, according to builders and real estate agents. "If you look at where the housing is strong, that is where retail construction is strong," said Ian Pierce, spokesman for the Weitzman Group. Retail construction in 2003 is expected to be half of the 4 million square feet that came onto the market in 2002, as a limited number of retail projects surface. Dallas Office Market Dallas Business Journal 8-08 According to the latest statistics, Dallas-Fort Worth has an overall office vacancy of 28%. With lackluster demand, that number isn't expected to improve much in the near future. The good news is things aren't getting any worse, said Nora Hogan, principal at NAI/Stoneleigh Huff Brous McDowell. Hogan and other brokers say they're seeing an increase in leasing activity, but mostly from smaller companies in the 5,000- to 20,000-square-foot range. At that rate, it will be a while before the plethora of available space is absorbed. What's worse, the market is facing an onslaught of more vacancy, with 30% of all sublease space expected to come back online before the end of 2005. "That's equivalent to 10 new 10-story buildings coming on the market," Hogan said. "It certainly will act to keep leasing rates depressed."
In a survey of 38 markets, Marcus & Millichap, which specializes in real estate investments, found that the vacancy rate for retail properties of 10,000 square feet or more edged up from 10.5% last year to 10.7% in the first half of this year. Zeroing in on one retail category, Reis said that at shopping malls with department-store anchors vacancies rose from 5.5% in Q1-03 to 5.7% inQ2-03. The Reis data shows that the Q2 vacancy rate at the malls actually represented an improvement over the period from the Q4-01 through last year. But Tom Dwyer, Reis's manager of retail solutions, said that in the aftermath of Sept. 11, widespread fears that shopping malls might be targets for terrorists discouraged retail tenants from taking space. Mr. Dwyer said the recent trend was disquieting because it can probably no longer be attributed to anxiety over terrorism. "It's definitely something to watch," he said, "because retail has very much held together while the other major sectors have not had an easy time." He said an adjustment was inevitable, given the rise in unemployment, the increase in consumer debt and the drop in consumer confidence. "I wouldn't be surprised if the vacancy rate continues to climb," he said. The vacancies are occurring in smaller, older regional malls of about 400,000 to 800,000 square feet, which have been losing tenants to larger malls with a minimum of three anchor tenants, Mr. Dwyer said. The larger malls occupy 800,000 square feet or more and are intended to draw customers from a radius of up to 25 miles. "They seem to be doing just fine," he said. Looking at shopping centers over all, Hessam Nadji, the managing director in charge of research at Marcus & Millichap, said he expected the retail vacancy rate to keep going up through the end of the year. "But then a correction should ensue," he said. "A lot of retailers have put their expansion plans on hold. They're waiting to see if the economic recovery is real." The slight increase in vacancies has not affected rents, which are still increasing, although at a slower rate than that of a few years ago, both researchers said. Nor has it slowed the feverish investment market. Sales of retail properties are continuing to outpace other forms of real estate investment, said Robert White Jr., the president of Real Capital Analytics, a research company that tracks sizable real estate transactions. Of the retail categories surveyed by Marcus & Millichap, the hardest hit were the power centers, with 250,000 to 600,000 square feet of space and three or more so-called big-box stores. Mr. Nadji said that during the last decade, this category was overbuilt. Vacancy rates are about 10 percent, an improvement over the late 1990's, he said. Surveying strip malls, Reis found that the average vacancy rate during the second quarter was 6.8%, the lowest level since the last quarter of 2001. Richard Latella, a managing director at Cushman & Wakefield. He said that prices for strip malls with supermarkets had begun to moderate, while the value of prime malls and power centers in good locations was going up.
But now - 25 years after Prop 13's creation - there have been calls for politicians to revisit the law. The state currently gets about 21.9% of its revenue from property taxes - which is below the national average of 28.6%, noted Wachovia Securities analyst Stephen Swett. Instead, the tax burden has shifted toward income and sales tax. Swett said Essex Property Trust would likely be affected most as its funds from operations would drop by about 22 cents a share, or 5%. Other REITs affected would be Kilroy Realty, Arden Realty Group, CarrAmerica, BRE Properties, and Bedford Property Investors, whose FFO would be lowered by 14 cents, 13 cents, 12 cents, 11 cents and 10 cents respectively. Each would see property taxes increase between 34% and 67%, according to Swett.
However, both warehouse/distribution and office service/showroom performance improved in the second quarter, according to Cushman & Wakefield, with positive absorption for the first time in more than a year. As a result, while overall absorption was a negative 19.8 million square feet for the first half of the year, that marked a 26.9% improvement over the same period in 2002. And while the national vacancy rate (including sublease space) rose by a percentage point at midyear 2003 over midyear 2002, reaching 10.1%, just nine industrial markets were "below equilibrium," according to the company.
But investors continue to snap up real estate shares, pushing inflows to $1.7 billion in the first half of this year, according to AMG Data Services. That figure is down from $2.7 billion during the same time last year, but remains on pace to match all of 2002's inflow of $3.4 billion, the highest level since 1997. "I wouldn't be rushing into them. They're very overpriced," said David Shulman, senior REIT analyst at Lehman Brothers. He notes that office vacancies remain quite high, while many apartment buildings are empty as prospective tenants take advantage of low interest rates and buy homes instead. Shopping malls continue to show good growth due to strong consumer spending, but their shares now may be overvalued, Shulman said. "REITs are trading 115 to 120% of net asset value," he said. "Most every stock is trading above their price target." "REITs make a good case for a majority of investors as a good diversifier in both the stock and bond market," said Dan McNeela, an analyst with fund tracker Morningstar. "There are some good long-term trends in the real estate industry, and investors can look to take advantage of that." Another REIT Bear Brendan Boyd, San Antonio Business Journal 8-4 Following gains of 27% in 2000 and 13.5% in 2001, REITs returned another 36% last year, with a 7% average dividend yield. Now David Shulman of Lehman Brothers, Institutional Investor magazine's top-rated REIT analyst, has turned bearish on the group, citing the continuing slow economy. Shulman thinks the next good year for REIT stocks will be 2005. He considers only four of the 64 REIT stocks he covers "buys" now: CenterPoint Properties, General Growth Properties, Rouse, Simon Property Group.
None of that means that happy days are here again for owners of office buildings, particularly in outer suburbs of Northern Virginia. Vacancy remains high by any standard, especially in Herndon (29% at the end of June), Reston (21.2%) and Tysons Corner (23.7%). And with 23.8 million square feet of space empty in Northern Virginia, the 700,000 square feet absorbed in the first half of the year help get the market back to normal only slightly. Maryland and the District have their own reasons for hope - and concern. The suburban Maryland office market, some analysts argue, lagged Virginia in worsening and will similarly lag in recovering. The biotechnology industry, heavily concentrated in Maryland, and technology and professional services firms north of the Potomac, did not collapse as quickly or as widely as Northern Virginia telecommunications companies. But are all grappling with difficult economic conditions of their own, among the factors behind a 15.3% vacancy rate in Beltsville and a Dulles Corridor-like 22.1% in Germantown.
"Are department stores in trouble? The facts say their position is unsustainable," said Howard Davidowitz, chairman of Davidowitz & Associates, a national retail consulting firm. He gives most of the department store chains a 50-50 chance of survival. Note: Dead Dept Stores = Dead Malls = Bad News for Mall REITs. "The problem is endemic with department stores as a whole. They don't own a niche," said Tom Rothschild, vice president of marketing for Millman Search Group. "They've become so promotional that the only time people shop the stores is for the one-day sale. The department stores hung themselves on a promotional nail, and now they're having a hard time getting off," Rothschild said. But department stores, typically with higher overhead costs than discounters, can't compete on price with discounters such as Wal-Mart, or on the selection of big-box category killers such as Bed Bath & Beyond. "Consumers believe that department stores are going to cost them 10, 15 or 20% more than what they'd pay at some other store or a big-box retailer for the same goods," said Britt Beemer, chairman and founder of America's Research Group. "Over the years, people would say, 'I didn't mind that, because I got service and help in the store,'" he said. "You didn't mind it because you got something for your 15% more." But as department store chains consolidated and focused more on the bottom line and cutting expenses, many of the publicly held companies have cut back on store help, analysts said. More Stats Anne D'Innocenzio, Associated Press 8-4 So far this year, department stores have posted a 3.9% decrease in sales at stores open at least a year, known as same-store sales. Same-store sales are considered the best indicator of a retailer's health. In comparison, discount stores have registered a 2.3% gain, while apparel chains had an increase of 2.9%, according to the Bank of Tokyo-Mitsubishi index. Wholesale clubs posted a same-store sales increase of 4.7%.
Simon has the biggest exposure - with nine of its malls being affected by the closings. Taubman and General Growth each have four malls that contain Lord & Taylor stores that will go dark. Taubman holds leases on two of the stores. The other six stores are owned by May Department Stores and therefore don't pay rent to the REITS. Rouse has three malls that will be affected, while Glimcher and Macerich each have only one Lord & Taylor store that will be affected. Although Simon has the largest number of stores on the list, the stores represent a smaller percentage of the company's overall portfolio than some of the other REITs that have fewer stores. Only seven of the 32 stores slated for closure pay rent to the REITs. The others are owned by the May Department Stores, said McDonald Investments Inc. analyst Richard Moore. However, their closure could affect the entire mall since they're anchor tenants. But Moore noted that unless the May Department Stores files for Chapter 11 bankruptcy protection, it must continue to honor its operating covenants for those locations. In other words, the company must either continue to pay rent or continue to operate the stores unless an agreement is worked out with the mall owner. If the company pays off the mall owner, it could give the REIT a short-term positive funds from operations, noted Morgan Stanley analyst Greg Whyte. Whyte said many mall REITs weren't surprised by the announcement. Several, knowing the stores had been underperforming, had been trying to line up replacement tenants in anticipation of store closings, he said. He doesn't expect any significant negative FFO revisions as a result of the announcement. Moore said bringing in a stronger performing tenant could actually benefit the entire mall and therefore the REITs. He named Neiman Marcus Group Inc. (NMGA), Nordstrom Inc. (JWN) and Bloomingdales as possible replacement anchors. From Christopher Edmonds TheStreet.com 2-13-02 Alexandria Real Estate Equities [ARE] specializes in a healthy niche: providing the roofs under which life sciences companies innovate. From core pharmaceutical companies such as Pfizer to small, private cutting-edge biotech companies, ARE specializes in laboratory real estate. That specialty provides solid returns. Since 1997, ARE has grown its FFO at a compounded annual rate of 18%. Even as the economy has slowed, ARE has remained healthy. "ARE's life science niche remains one of the few pockets of strength in the real estate market," says Steve Sakwa, REIT analyst at Merrill Lynch. "ARE continues to see strong demand for its lab/office properties despite an expected weak economy for most of 2002." Sakwa rates ARE strong buy, and his firm has not provided banking services for the company. Fueling ARE's continuing growth is robust research and development spending among life sciences companies. According to data from Goldman Sachs, pharmaceutical and biotech R&D spending increased 8.5% in 2001. Plus, the National Institutes of Health's budget will increase 15% in 2002, and Bush's 2003 budget proposes another 16% increase next year. With 92% of Alexandria's tenant base focused on research, that budget growth supports demand for space. Nearly 80% of Alexandria's tenant base is renewing leases as they expire. "We believe the tenant retention rate would be even higher if not for Alexandria's elective decisions," says Jim Kammert, REIT analyst at Goldman Sachs. "Management remains focused on upgrading its tenant base as it places assets into the redevelopment process or releases existing space. Alexandria's tenant base is not only differentiated from other real estate owners and operators, but is also less vulnerable in the event of an economic downturn," says Kammert. ARE is on Goldman's recommended list. The risks associated with Alexandria are its tenants. Many are unprofitable and depend on scientific funding and grants for sustenance. If scientific research funds contract, it would likely affect a broad spectrum of Alexandria's tenants, making re-leasing difficult. Similarly, Alexandria's portfolio is concentrated along research corridors and designed for its niche market, making leasing to nonresearch tenants impractical. Public and private funding sources appear committed to continued funding for life sciences research. And ARE's discerning taste for tenants would ease the pain of any downturn. "ARE's thorough understanding of its tenant base and each company's revenue stream or long-term funding arrangements further enhances [its] defensive nature," says Kammert. Its balance sheet is clean - sporting a debt-to-market-cap ratio of about 45% - and it trades at a discount to its net asset value, which Kammert calculates at about $45 a share. Christopher Edmonds RealMoney.com 8-13-03 Alexandria continues to post solid growth in an otherwise soft office market. Earlier this week, Alexandria announced funds from operations, or FFO, a REIT's measure of earnings, of $1.05 a share for Q2-03 vs. the year-ago 97 cents, and slightly better than expectations. Moreover, while many office REITs are struggling just to keep same-store net operating income from slipping fast, Alexandria actually saw NOI increase by about 2% in Q2. While traditional office-building landlords have struggled to keep tenants from walking and rents from slumping, Alexandria has seen demand and lease rates grow modestly. In fact, the average office REIT has seen occupancy decline by at least 2% and rents decline by about 10%. Alexandria's rent and occupancy have remained relatively stable. In the second quarter, Alexandria saw occupancy growth of about one-half of a percent, as well as modest rent increases. The outlook in the coming quarters is relatively buoyant, as well, when compared to the rest of the REIT market. The company has seen very little tenant loss in the economic malaise and expects to see same-store NOI growth in the 2% range in the coming year. The company continues to have good traction with existing clients. In the second quarter, Alexandria closed nearly 80,000 square feet of leases, with about a third consisting of lease renewals. To one analyst, the re-leasing activity was generally positive. "These deals had rent increases of 12% on a cash basis, which is quite strong, but it was a small sample," said Anthony Paolone, a real estate analyst at J.P. Morgan. "The company leased about 48,000 square feet of space relating to developments and redevelopments. These deals were done with average lease terms of 5.6 years, which is good." Paolone rates the stock overweight. Paolone also said that in 2004, the company will have about 11% of its property portfolio rolling over, about normal for Alexandria. The company noted that about 35% of that space already has commitments, which is a good sign this early in the renewal process. Although growth hasn't been as robust as in past years, this year should be no different for those looking for a payout increase. Alexandria has traditionally adjusted its dividend in the first quarter, but management has hinted that its board is likely to approve a dividend boost at its September meeting. That's largely because a lack of acquisitions has left the company sitting on a pile of cash and not as much need for capital. That possible special dividend increase isn't likely to preclude the traditional hike that could come in the first quarter of next year. There were bugs in this program that caused the initial calculation of equivalent shares for IFC and RWR to be overstated. While the dollar amounts are not comparable, the percentage gains are.
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