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Things aren't likely to change quickly. Developers started construction on 397,000 apartment units in December, the fastest pace since February 2000. Meanwhile, mortgage rates are close to their lows of last summer. The difference between the cost of homeownership and typical apartment rents has narrowed in about half of the nation's 50 largest metro areas since the end of 2000, according to M/PF Research. Research firm Economy.com estimates that the low rates last year resulted in 358,000 additional households bailing out of apartments to buy a home. That's the macro picture. The micro picture is that landlords' pricing power varies greatly from market to market, depending upon how strong the local economy is and how many new apartments have been built. Atlanta, Austin, Dallas, Denver, Northern California, Portland, Ore., and Seattle continue to be renters' markets, where renters can expect to be offered lots of deals. Markets where landlords continue to generally hold the upper hand include parts of Southern California, Washington, D.C., Baltimore, Philadelphia, and south Florida.
Still, properties that traded hands in Q4 continued to sell at a premium, going for $164.40 a square foot, 22% more that the value reported in the Reis survey. That's because investors continue to invest a large amount of money in real-estate. "Almost every pension fund has increased its allocations for real estate this year," says Bill Shanahan, an investment-sales broker for CB Richard Ellis. That inflow of cash drove the capitalization rate down to 8.7% in Q4 from 8.9% in Q3. The capitalization rate is the estimated rate of return on a property at the time of the purchase. The apartment market went the other way in Q4-03, with absorption hurt by uncertainty over the economy and the huge numbers of single-family homes being purchased. That caused value growth to slow to 0.3%, with values moving to $68,848 per unit in Q4 from $68,642 in Q3. Apartment values had grown 1.9% in the third quarter amid strong positive absorption. But absorption fell off sharply in Q4. The capitalization rate for apartments edged down to 7.3% in Q4 from 7.4% in Q3.
Firms in the US office and multifamily sectors remain vulnerable as weak fundamentals continue to stress their operating results and tenant demand remains fragile, the study says. At the same time, the pace of deterioration has slowed, while leasing velocity seems to be improving. The rating outlook for the US office REIT sector remains negative, with one of the key challenges being the drag on occupancies, given the lack of meaningful jobs growth and corporate investment. Many landlords - particularly those with large blocks of space - may find it difficult to retain tenants as firms rethink their long-term space needs. Generally, US mall REIT performance has held up well during the current economic cycle as evidenced by positive revenue and earnings growth, particularly from in-line store tenants and strong productivity.
There are now 144 publicly traded equity real-estate investment trusts companies in the U.S., up from 58 in 1990, while the industry's total market capitalization has grown to $204.80 billion from $5.55 billion in 1990, according to the NAREIT. A record $4.77 billion flowed into real-estate mutual funds in 2003, according to AMG Data Services, which surpasses the $3.36 billion that flowed into these funds in 2002 and the $46 million invested in 2001. Corporations Shedding Real Estate Corporations - such as IBM, John Hancock Financial Services Inc., Citigroup, AT&T and MetLife - have been cashing out real-estate holdings. Property sales by corporations totaled $7.8 billion in 2003, up from $7.3 billion in 2002, according to Real Capital Analytics. Such sales may pick up further this year if the U.S. adopts international accounting rules that require corporations to report assets on balance sheets at current market value rather than at book value or on a depreciated cost metric, which factors in an asset's depreciation. That may get some companies to rethink owning because using the international standard would in some cases increase the asset's value on the balance sheet. Focus of REITs on Operations During the mid- to late 1990s, real-estate investment trusts were perceived simply as collectors of property -- developers and acquirers with no clue how to run a business. And many of them were just that. But since the late 1990s, they have become more involved not just in the running of their properties but in the running of their companies, too. What this means is that REITs started paying more attention to what Wall Street and investors thought as opposed to just thinking about the next big acquisition or the next big development without regard to how it would affect shareholders. In fact, Standard & Poor's cited REITs' evolution into operating companies as one reason why it began admitting the companies into its indexes in 2001. So what happened? REIT stocks went through a bear market in 1998 and 1999, which meant the trusts couldn't raise equity to make more acquisitions or develop property, and were forced to focus on operations. Also, REITs started to seek money through debt offerings and "started acting more like public companies in order to qualify for ratings" from debt-rating agencies, says Charles F. Lowrey, CEO of Prudential Real Estate Investors. C. Bradley Olson, director of the real-estate program at Cornell University, sees the trend continuing this year, especially in light of the still-weak economy, because "REITs have to be very concerned about keeping their buildings occupied and about price and length on renegotiated leases." Information Revolution What do you want to know about commercial real estate? Just name it. Nowadays there's more information at your fingertips about the industry than ever before. You can find everything from vacancy rates and rents to price comparisons; from lease and sales information to market trends; as well as in-depth analysis and forecasts. The abundance of data has helped all investors, public and private. Many analysts credit data availability with helping prevent a real-estate crash like the one in the early 1990s. "You can explain some of the volatility historically of real estate because we didn't have information," says Steven P. Laposa, director of the global strategic real-estate research practice at PricewaterhouseCoopers. The demand for data has been so hot that some of the data providers are mulling growth plans. CoStar Group Inc., Bethesda, Md., expanded into London early last year. CoStar is looking to broaden its database to include secondary and tertiary markets. (The firm currently tracks 50 major U.S. markets.) Torto Wheaton Research, Boston, plans to introduce historical data and forecasts for seven Canadian office and industrial markets this year, and to boost its offerings with investment-strategy services and a debt-risk management product.
In a note, Merrill Lynch's Mr. Sakwa said he believes REIT "fundamentals have bottomed and earnings growth should show sequential improvement throughout the year." He sees factory outlet REITs generating the biggest earnings growth, followed by self-storage REITs and regional mall REITs. Still, Mr. Sakwa cautioned, "The $64,000 question is whether REIT valuations will hold at these high levels, or whether the sector will come crashing down a la 1998/1999." Job growth, consumer spending and fund flows are all factors, he said. Goldman's Mr. Callahan is only calling for 3% funds from operations growth for REITs in 2004 and 4.5% FFO growth in 2005. "This growth is lackluster relative to other (non-REIT) sectors," he said, in a note. At the same time, Mr. Callahan said valuations are nearing their highest point in more than six years. The 35 REITs that Mr. Callahan tracks trade at an 18% premium to their net asset value, or NAV, on average, he wrote. As a result, "we see potential for 10% to 15% correction," he wrote. Mr. Callahan sees rising interest rates, a flattening yield curve and a shift toward growth stocks as possible catalysts for a correction. Prudential's Mr. Sullivan said REITs appear "richly priced." In a note, he said "we believe [the REIT sector] is more ripe for a correction that could result in negative total returns for 2004." Piper Jaffray analyst Andrew Rosivach is predicting positive 5% returns, thanks to the dividend yield. However, he believes non-REIT sectors may be more attractive for investors. For example, REIT earnings growth is expected to be flat with 2003, while S&P 500 earnings are expected to rise 8% to 9%, Mr. Rosavich said in a note. Also, the 2003 Federal Tax Plan, which chopped personal income taxes on dividends, helped to make the broader market equities more attractive. Some analysts are reluctant to make predictions beyond the first half of 2004. Deutsche Bank analyst Louis Taylor is predicting positive total returns of 10% to 12% in the first half of 2004, due to positive investor inflows into the REIT sector. "Everybody's been calling for [a correction] since last June, and yet money keeps flowing in," he said. However, Mr. Taylor declined to give projections for the second half of the year. When interest rates start rising, anything can happen, he said. Much will depend on how much and how quickly rates rise, he said.
Some warehouses stored cartons of soaps and detergents, fast-moving items that can be stacked on top of each other. Other warehouses contained hairsprays and other products that are ordered in smaller quantities and have to be handled more carefully because they come in aerosol containers. Truck drivers had to make multiple stops to fill their trailers, raising delivery costs. To make its distribution system speedier and less costly, Unilever turned in 2001 to ProLogis, a REIT that helps companies solve their logistic problems - not only by developing the warehouses but also by advising on new locations and local labor issues, overseeing negotiations for government incentives, securing financing and even contributing to the design of the racks inside the buildings. Two and a half years later, Unilever had whittled its distribution network to five warehouses while losing only 500,000 square feet of office space. Each warehouse has 32-foot ceilings, occupies a million square feet and is one mile in circumference, except for a $15.5 million, 442,000-square-foot building in Dallas, which serves Louisiana, New Mexico, Oklahoma and Texas. Each distribution center accommodates all the Unilever lines. The manufacturer says it has lowered its distribution costs by 7%. The new system has saved Unilever $20 million a year, Mr. Berkheimer said. The biggest savings have come in trucking and freight costs because each warehouse is equipped to handle all Unilever products, eliminating the extra stops. Cost (including land, but not equipment) of the distribution centers ranged from $40 a square foot in Rialto to the "high $20's" in Mesquite, said John Seiple, the COO at ProLogis North America. Rents are generally from 9.5% to 10% of the building's cost, he said. With the exception of the Palmetto warehouse, all the buildings are owned by Macquarie ProLogis Trust [listed on the Australian stock exchange]. ProLogis has retained a 15% interest in the properties. Unilever's consolidation reflected, in part, the urgency that manufacturers feel to reduce distribution costs in response to pressures from Wal-Mart and other big-box retailers. These pressures are having a "profound effect on the warehouse business," said James Sullivan, a senior analyst at Green Street Advisors. "In an economy in which it's hard to raise prices," Mr. Sullivan said, "companies have increasingly looked at the cost side and tried to figure out how to improve the bottom line. More and more warehouse users are employing this strategy." Fred Berkheimer, VP for logistics at Unilever, acknowledged that demands from larger retailers drove the company to rethink its warehouses. "You have to find ways to suck waste out of the system," he said. "Some of the larger retailers push pretty hard." Arlene Isaacs-Lowe, a senior VP at Moody's, said it made sense for manufacturers to deal with a single real estate company rather than a different one in each market. "There isn't a lot of uniqueness to the kinds of facilities they want," she said, "and it's far more consistent for them to deal with one developer who has expertise in a number of different markets." Other developers are also building larger warehouses in response to the proliferation of product variations. Five years ago, said Ted Antenucci, the president of Catellus Commercial Group, a division of Catellus Development Corporation of San Francisco, warehouses were usually 350,000 to 500,000 square feet. "Now," he said, "there is a lot of demand for warehouses over 600,000 square feet." Catellus has drawn repeat business from many clients, including Ford Motor, Gillette and Kellogg's, Mr. Antenucci said. But he said it was unusual for one developer to build an entire network of warehouses for one manufacturer, as ProLogis did.
Nevertheless, there are some encouraging signs. Reis reports that in 2003, the industrial sector had the lowest level of construction in over 10 years - 44.5 million square feet - and its first positive, albeit meager at 4.7 million square feet, net absorption since 2000. Moreover, according to the Institute for Supply Management (ISM)'s data, manufacturing activity has begun to turn around, with December marking the sixth consecutive month of increase. Good news for the economic health of the sector and its investors given the size of the industrial REIT market, which, according to the year-end 2003 data complied by NAREIT, puts the total market capitalization of industrial REITs at $13.1 billion, or 6% of the $204.8 billion REIT universe. To see how the industrial market - and the REITs working in that sector--are faring, Reis's Sam Truitt spoke with Jim Sullivan, principal at the real estate securities research firm Green Street Advisors. Truitt: How long is it going to take for vacancies in industrial space to hit bottom? Sullivan: We are probably there: We've seen a tremendous uptick in manufacturing activity over the last couple of months, which should translate into more demand in 2004, and at the same time, we have seen new supply slow down significantly. Improved demand combined with a reasonable rate of supply likely means we are very near to bottom in respect to vacancy levels. Truitt: If the economy holds, will industrial REITs prove a more popular asset class? Sullivan: Industrial has historically reacted more quickly than other property types in response to a recovering economy. And the recovery is dependent more on economic recovery than on job creation. Truitt: Is there a bellwether to indicate resurgence in the demand for industrial space? Sullivan: I wish it were that simple. The answer is quite different depending on what area of the country you are talking about. Markets like Southern California, which are heavily dependent on distribution activity, have done well and will continue to do so. The improving economy will only help that situation, which is already strong. Places like Dallas, which are more a blend of distribution, tech-related activity and manufacturing, have done quite poorly: I would say the outlook there for 2004 is still spotty, particularly when it is so easy to build more industrial space in such a land-abundant market. Atlanta is a tough market. Columbus and Indianapolis each have high vacancy rates. Truitt: Which industrial REITs are particularly vulnerable in those areas? Sullivan: The national guys - ProLogis and AMB - are in Dallas and Atlanta in a big way, but relative to the size of their portfolios, it's not something to lose sleep over. Truitt: What part does shadow space play in this recovery? Sullivan: While shadow space has been thoroughly scrubbed in relation to office space, it is not well understood as it relates to the industrial sector. One of the things concerning me about industrial, and the pace of its recovery, is capacity utilization figures for industrial and manufacturing space. We're at all-time lows there. During an even part of the economic cycle, utilization runs at about the mid 80-percent level. For the last several quarters, we have been running in the mid-70s. This suggests that there is a lot of manufacturing/industrial space out there that is owned or leased but not being used. As the economy gears up and activity increases in the industrial and manufacturing sectors, clearly more space will be utilized, but I question whether it will be new space or companies simply growing into space they already own or lease. I don't know the answer, but it is something to consider. Truitt: Taking into account the particular dynamics of the current economy, which REITs do you think are best positioned to take advantage of a turnaround? Sullivan: There are several: The industrial REIT group is populated by some extraordinarily excellent companies, but they are excellent for different reasons. ProLogis and Catellus, for example, are great developers: An improving economy, leading to more industrial demand, leads to new building demand, which plays to their strength. Duke would be in that group as well. Liberty is another name I would throw in. Centerpoint is maybe qualitatively the best real estate company in terms of development, redevelopment, leasing and property management. In addition, they are concentrated in Chicago, which is the largest industrial market in the country. They are extraordinarily well positioned. Finally, AMB is a company that has a portfolio concentrated in the key industrial markets: Seattle, Southern California, Atlanta, Dallas, Chicago, Northern New Jersey and Florida. They own property in the right places. Each of these companies is well positioned and has superior abilities, as compared to their competitors on the private side. That bodes well for them. That said, for us it's always a question of: "Is that already priced into the stock?" Truitt: Good point . . is a rally already priced into the sectors' valuations? Sullivan: You will get a lot of different opinions on that. In our view, the anticipated recovery is already figured into the share prices of each of their companies. Truitt: Was Catellus' conversion to REIT status advantageous? Sullivan: Hugely advantageous. As a C Corp, they had to pay corporate taxes. For many years, because of previous losses, they haven't had to, but they were getting to the point where those previous losses were burning off. By converting to a REIT structure, they are able to sidestep those payments. From a financial standpoint, they are saving a lot of money - putting it into their shareholders' pockets, as opposed to paying it in taxes to the government. It has also forced them to simplify and focus their story. Industrial development had been a single part of their business before: Now it's their core concentration, from a strategic point of view. That simplification was a positive step. Truitt: What's going to be happening to older, more obsolete space? Sullivan: It depends on where it's located. If it's in a market like Atlanta, that space is probably going to be in for some trouble, because you can go to the next freeway interchange and build a more modern facility at comparable cost. In a place like Port of Los Angeles, older buildings can be very valuable, despite functional obsolescence, according to the modern definition. So, it's highly dependent on the market: In those markets where it's easy to build new product, the older stuff is much more at risk than infill locations. Truitt: ProLogis touts its capacity to manage space. How valuable is that to investors? Sullivan: Not all that valuable if you are talking about property management, which is a very people-intensive and low-margin business. ProLogis is very good at it, but it's a small part. For a company of their size, it doesn't really move the needle. Truitt: What challenges does the industrial sector face going forward? Sullivan: That national vacancy rate according to Reis is about 12%: That's the highest the rate has been since 1983 and represents about 1 billion square feet of vacant space--the most there's ever been. I don't think it's a matter of a quarter or two before we fill enough space to allow industrial landlords in most markets to have much power over their tenants. So, while the economic indicators are pointing to a recovery in the sector, we have a pretty deep hole to dig ourselves out of before things come to equilibrium--let alone a more favorable environment. It's different market to market, but on a national level that's probably the biggest challenge. My second concern is that industrial developers are anticipating this recovery as well. Significant growth in development activity could be very good news for those doing the development, but will be less so for those whose tenants are being taken across the street to that new building. Given that the development spigot for industrial space can get turned on and off pretty quickly - say in six to 12 months, versus the 18 months to three years, say, for an office building - developers inspired by economic conditions to accelerate their activity could cause that spigot to be turned too far, too quickly. Industrial Stats The industrial real estate market closed out 2003 with negative absorption according to research by Grubb & Ellis. The fourth quarter of 2003 ended with a 12.7% vacancy rate with tenants vacating 289,000 square feet. The report indicated that while a total of 2.7 million square feet of industrial space was vacated last year, 2004 holds promise as companies increase production and look to expand operations. Rents have declined to between $5.50 to $6 per square foot. (Michelle Hillman, Boston Business Journal 2-20)
Top Stocks for 2004 As we look into 2004, in light of REIT valuations and economic growth projections, we are convinced that outperformance this year will likely be concentrated in the more economically driven sectors, which have greater earnings sensitivity to economic growth. Stocks that we expect to outperform in 2004 include: Host Marriott, LaSalle Hotels, Prentiss Properties, Equity Office Properties, Equity One and Cedar Shopping Centers. FFO Growth First Call consensus estimates for our index of 113 REITs currently shows a projected 3% FFO per share decline for 2003, reversing to positive growth of 5% per share in 2004. We believe the odds favor REITs meeting consensus growth estimates this year, given that fundamentals, while yet to improve materially, have stopped deteriorating in the more troubled sectors. The majority of the FFO growth is expected to be generated by the consumer driven sectors. The regional malls and shopping center sectors are each expected to grow FFO per share in the 7-10% range, and lodging is finally expected to turn the corner with 17% per share growth. More on NAV Based on our NAV analysis of the 36 REITs in our coverage universe, we estimate that the stocks currently trade at an average premium to NAV of 15.5% (using a weighted average). Current valuations stand in sharp contrast to the 3.0% discount to NAV at this juncture one year ago. Trading at significant premiums to their NAVs are numerous office, industrial, apartment and lodging REITs such as SLG (+33%), OFC (+32%), EGP (+21%) and EQR (+18%). Falling cap rates, improved NOI run rates (across some of our coverage universe) and balance sheet restructuring all combined to drive 1.7% year-over-year NAV growth. The biggest year-over-year decline, 23.5%, occurred in AIV. Excluding AIV from the weighted average, NAVs increased 3.0% year-over-year. On the other side of the NAV growth spectrum, Corporate Office Properties (+24.6%), American Land Lease, (+21.3%), Capital Automotive (+18.9%) and Regency Centers, (+15.1%), each posted strong year-over-year NAV growth. Also posting outsized year-over-year NAV growth were Agree Realty and Parkway Properties, at 44.8% and 21.8%. Based on our analysis of 25 REITs for which we were able to calculate the year-over-year change in NAV, 15 increased NAV. More on Yield Spreads We see little if any upside from a yield perspective. According to NAREIT, the average equity REIT dividend yield stands at 5.5%, 140 bps below the 7.0% average dividend yield as of January 1, 2003, but 140 bps above the 10-Year treasury. The average equity REIT Yield spread over the 10-Year Treasury since 1987 has been 95 bps. But more importantly, over the past ten years, this yield spread has been 140 bps, or the approximate spread currently. The yield spread has varied considerably over this past ten years. With the five years leading up to July 1998, or the beginning of the correction in the REIT market, the spread averaged a mere 41 bps. Subsequent to July 1998, the spread has averaged 223 basis points. With the relatively low earnings per share growth expectations for 2004 and 2005, combined with modest interest rate pressure, we see little possibility that this spread narrows. Should it narrow, we believe it would be more as a result of the ten-year yield rising than REIT yields dropping. A Looming Correction? Is a repeat of the 1998-1999 REIT correction looming? (REITs had total returns of -17.5% in 1998 and -4.6% in 1999) We do not believe that history is set up to repeat itself. First, recall that in 1998-1999 the sector was exiting from a period of huge capital inflows, much of which came from growth-oriented buyers pursuing a red hot REIT IPO market. One point that Raymond James could have made on how 2004 will NOT be like 1998-1999: [From Prudential Real Estate Investors] At year-end 2003, REITs were trading at a price-to-FFO multiple of more than 12x, well above the 11.2 average multiple since 1993, but well below the 1997 peaked at more than 14x. In 1998, funds flow into REITs turned sharply negative as investors moved 'growth' money into tech and telecomm stocks. We believe that today many investors anticipate a period of stock market returns in the mid- to high-single digits. REITs, boasting a 6%+ average yield and the prospects of future dividend increases, should continue to look appealing. Many of today's REIT investors are yield-oriented. Thus the inflows today are 'stickier'. A bit more information about recent inflows: [From Prudential Real Estate Investors:] Investors have poured more than $15 billion in capital, or about 7% of the total US REIT equity market capitalization, into the REIT market through REIT mutual funds and closed-end funds (with leverage) since the start of 2002. Prudential theorizes that fund money will be 'stickier' than other money that has flowed into REITs. Further, while the 1998-1999 period was characterized by strong real estate fundamentals and reasonable growth prospects, we were also nearing the end of a fundamental up cycle. Today fundamentals are nearing the start of a recovery after a fairly sharp down cycle. We believe it is highly unlikely that REIT share prices materially decline in an environment where better economic prospects drive improved real estate fundamentals and improved cash flow growth prospects. This summation is from the first 22 pages of a 95 page report. If you are a REIT investor, you should take the time to read the whole report.
But the U.S. vacancy rate continued to rise in Q4 by 10 basis points and now stands at 16.9%, the highest level since 1993. There is also evidence that at least some of the 3.7 million square feet of positive absorption was purchased by landlords using the currency of richer concession packages, typically in the form of free rent and above-standard tenant improvement allowances. Nationally, after factoring in these concessions, effective rents were down 0.7%. The average gap between asking and effective rents now stands at 16.4%, 730 basis points above its low at the end of 2000. For landlords in Denver, New Orleans, Portland, and Raleigh-Durham that figure is above 20.0%. The national average cumulative loss in effective rents since the onset of this downturn has risen by 830 basis points, and the quarter brought only more pain to markets that have already suffered inordinately. 'Leading' the pack in effective rent declines are the following usual suspects: Oakland (-2.1%), Austin (-1.9%), and San Francisco (-1.6%). These markets were joined by relative newcomers Orlando (-1.8%), and Memphis (-1.6%). The five markets that finished the quarter with the highest vacancy rates are no surprise: Dallas (26.7%), Austin (23.6%), San Jose (23.5%), Denver (22.1%), and San Francisco (22.1%). Of the top 50 markets, 34 saw their effective rents drop in Q4. Last quarter we reported that only two markets recorded increases in both effective rents and declines in vacancy rate. This quarter that number jumps to nine, and among those the following six were standouts because they recorded positive absorption even in the face of new inventory growth: San Diego, Palm Beach, Kansas City, Ft. Lauderdale, Norfolk, and Portland. We can state with reasonable confidence that the U.S. Office vacancy rate has topped out. Despite the disappointing pace of job formation so far, the current level of economic expansion will necessitate the hiring at a progressively faster pace as 2004 unfolds. As a result, Reis forecasts 26.7 million square feet of positive absorption in 2004, which represents a significant turnabout after the last three years of negative performance. And while we anticipate the completion of 28.2 million square feet, the absorption-to-completion ratio will be sufficiently favorable to facilitate stabilization or perhaps even a modest decline in the vacancy rate.
In 24 of the top 50 U.S. markets, the average effective rent rose during the quarter, and in LA (1.7%), San Diego (1.6%), DC (1.6%), and San Bernardino (1.3%), among others, performance was unabashedly enviable. Those same markets did well for the year, logging 4.1%, 3.1%, 3.7%, and 5.9%, respectively. All recorded modestly positive absorption for the year and vacancy rates hovering comfortably in the 4.0% range. Boston, Portland, Milwaukee, Fairfield County, and San Jose, saw effective rents sink during the fourth quarter by 1.7%, 1.4%, 1.3%, 1.3%, and 1.3%, respectively. San Jose has the dubious distinction of being the worst performer of the top 50 U.S. markets for 2003, with rents dropping a total of 9.2% for a cumulative decline of more than 36.0% since Q1-01. The pace of new completions, which has averaged a robust 27,800 per quarter since negative absorption first appeared in this cycle ten quarters ago, was almost exactly that again in Q4. Not surprisingly, Reis findings indicate that the average vacancy rate in the U.S. apartment market climbed 30 basis points last quarter to 6.9%, the highest level since 7.2% in 1988, and 390 basis points above its cyclical trough in the third quarter of 2000. Although new construction projects are on track to add more than 25,000 units to the market each quarter during 2004, and job growth is unlikely to produce a corresponding number of tenants, Reis does foresee in 2004 relative stabilization of the Apartment market. Conflicting signals will be sent in 2004 as both vacancies and effective rents rise mildly, but we believe that the environment may 'feel' better to most apartment investors. This shift will constitute a modest improvement, hardly a sea change. Investors must wait until 2005 to find themselves competing in a market where the currents of occupancy and rent change are more favorably temperate.
Two possible sources of the unique stability in Retail are the relatively sober pace of new construction (only 6.9 million new square feet completed during the quarter), and the expansion-mindedness of some retailers who seem willing to take on ever more new space to generate revenue growth and guard against the possibility of flat or declining sales in existing stores. In only five metros did landlords feel compelled to lower their asking rents: Columbus (-0.7%), Indianapolis (-0.6%), St. Louis (-0.5%), Sacramento (-0.4%), and Boston (-0.4%); and despite this, two of these markets, Indianapolis and Sacramento, managed to post modest effective rent gains, suggesting that landlords there are more than making up the drop in asking rent by reducing the value of TI and free rent concessions. Fourth-quarter standouts in effective rent increase include Palm Beach (2.3%), Kansas City (2.1%), Chicago (2.1%), Charlotte (1.8%,) and Orlando (1.8%)., Kansas City and Orlando had vacancy falling by 100 basis points. San Diego had the lowest retail vacancy rate in the nation, 2.9%, and Seattle, Suburban Virginia, and San Jose, and San Francisco all posted vacancies lower than 4.0%. Only five markets finished the year with vacancy rates higher than 10.0%: Charlotte, Richmond, Indianapolis, Cincinnati, and Memphis. Negative absorption was recorded in all of these markets except for Charlotte, which posted positive absorption totaling 199,000 square feet. Even in those metros that recorded the heaviest completion activity, the additional supply does not appear to have been more than the market could digest. Completions in Atlanta, San Bernardino, Surburban Maryland, Suburban Virginia, and Cleveland averaged nearly 500,000 square feet and accounted for approximately 35% of new space introduced into the U.S. market, yet in these metros vacancy rates fell an average of 30 basis points and effective rents rose by an average of 1.2%. Despite ReisĖs expectation that the retail vacancy rate will drift upward to just below 8.0% by the end of 2005, the rise should be gentle enough - and signals suggest that the economy may be strong enough - that effective rents too will continue to climb. Quick Facts, Stats & Opinions James Corl, a portfolio manager at Cohen & Steers Capital Management, notes that "real estate is something of a late-cycle performer." Corl predicts REIT profit growth will increase this year in the mid-single-digit range, and 8% to 10% in 2005. Plus, "the supply of real estate being delivered is declining at same time when demand for real estate is beginning to ramp up again," Corl explains. As for the specter of rising interest rates, Corl says he's not worried. He contends that higher rates can augur well for property owners, especially if, owing to modest inflation, they can get some pricing power. And interest-rate increases often go hand in hand with a strengthening economy. (Lawrence Strauss, Barrons 2-16) In "Call of the Mall", Paco Underhill writes "Today, malls account for around 14% of US retailing (not counting cars or gasoline)." What these suburban emporia have in common are indistinguishable and ill-defined entrances, and a lack of venues where one can linger, like a book store, home electronics store, or office supply store - retail categories that typically attract adult males. (Carlo Wolff, Boston Globe 2-15) Analysts said they do not expect the flow of capital to real estate to slow anytime soon. Many investors believe that real estate fundamentals have bottomed out and will improve this year. Plus, new investing rules overseas are expected to allow foreign investors to pour more cash into U.S. real estate. Japan, for instance, recently permitted investors there to buy shares in U.S. real estate stocks. (Tim Lemke, Washington Times 2-13) The Stanger Report is a quarterly industry report [$447 a year] which lists dozens of private REITs, describes their strategies, and rates them. After a set period of time - usually seven to 14 years - private REITs are either taken public or liquidated and the proceeds are distributed to investors. (Ray Smith, WSJ 2-11) "Over the next five years, we see total returns for real estate funds in the more traditional range of 10% to 12% a year," said Kenneth D. Statz, a manager of the Security Capital U.S. Real Estate fund. Over the last five years, the average real estate mutual fund has generated a total return of 15%, annualized, compared with 3% for domestic stock mutual funds. (John Kimelman, NY Times 2-01) Dan McNeela, a real estate fund analyst at Morningstar, pointed out that active managers generally outpaced their index-oriented rivals in real estate investment in recent years. Over the last seven years, Morningstar has tracked the performance of the Vanguard REIT Index fund versus that of active real estate fund managers. The index fund, he said, has outperformed in only one of those years. (John Kimelman, NY Times 2-01) Public mall REITs continue to generate strong internal growth, with spreads on lease renewals of about 25% and same-store net operating income growth of between 3% and 6%, according to Prudential Equity Group. And malls have finally managed to de-link their fate from that of their department store tenants, whose decline has been an albatross around the industryĖs neck for years. As mall owners have become more adept at re-leasing dark department store space, the potential loss of these anchors no longer carries the stigma it once did and may even represent an opportunity to unlock some upside potential. (Prudential Real Estate Investors Jan 04) Update: Second Experiment in Stock Picking 2-27-04 A sector balanced portfolio is summed and compared with the average of two REIT index ETF's: ICF [Cohen & Steers Realty Majors - the top 30 REITs by market cap] and RWR [the REIT Wilshire Index]. The first experiment went from Nov 02 to Oct 03 and this experiment began at the end of April of 2003. NOTE: ICF and RWR dividends were added on 12-24, but ICF appears to be having a second special dividend to be paid in December. So their combined gains may still be slightly understated. As of 2-17-04, the December IFC dividend is listed as "to be announced". ICF divs again on 3-29. I do not know what to make of a December Dividend that is still "to be announced". Earnings Guidance: CARS expects 2004 FFO of $2.52 to $2.56 a share, up from its prior guidance range of $2.47 to $2.52 a share. Thomson First Call currently targets FFO of $2.51 a share for the year. On 1-21 CARS increased its quarterly dividend to $0.4165 from $0.4140. The new annual rate is $1.666 per share. CARS also reaffirmed its 2004 annual dividend guidance of $1.70 per share. The company expects 10% to 15% of that dividend to be a return of capital. RSE expects FFO of $4.10 to $4.20 per share in 2004. The forecast trails analysts' average expectations for FFO of $4.27 a share, with nine estimates ranging from $4.20 to $4.35. RSE increase in its common stock cash dividend to 47 cents a share from 42 cents. RSE expects that only 30% of 2003's cash dividend will be subject to the standard income tax rates, while the rest will qualify for the lower 15% federal tax dividend rate instituted in mid-2003. AMB gave 04 FFO guidance of $2.30 - $2.40/share in their Q4 conference call on 1-14-04. The current consensus estimate is $2.34. AMB declared a regular cash dividend for Q1-04, of $0.425 per common share. The dividend reflects an annual rate of $1.70 per share, an increase of 2.4% over the 2003 dividend of $1.66 per common share. The dividend will be payable on 4-15-04, to common stockholders of record at the close of business on 4-5-04. UDR estimates that recurring cap-exp for 04 will be $470 per apartment home, or $0.25 per share. UDR's guidance for 2004 FFO is a range from $1.48 to $1.60 per share; and guidance for Q1-04 FFO is a range from $.37 to $.38 per share. OFC gave 04 FFO guidance of $1.66 - $1.71/share in their Q4 conference call on 2-11-04. The current consensus estimate is $1.69. MLS increased the common stock cash dividend for Q1-04 by 5.3% to $0.595 per common share. The dividend will be payable 5-3-04 to shareholders of record on 4-23-04. MLS 2004 FFO Projection: $3.90 - $4.00. The current consensus estimate is $3.96.
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