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Local REITS' long-term success uncertain despite strong past performance

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The consequences of higher interest rates -- intended and unintended -- are having an impact on one popular segment of the stock market: real estate investment trusts.

Like most things related to real estate, these exchanged traded portfolios have been a favorite with Main Street investors seeking solid dividend income. However, Wall Street analysts have scoffed at REITs as investments that cannot compete with more aggressive, growth stocks. But, the numbers say something different. According to the National Association of Real Estate Trusts, an index of publicly traded trusts averaged a total return of 13.80 percent between 1975 and 2005. That compares to a 12.70 percent return for the Standard & Poor's 500 and 8.80 percent for the Dow industrials during the same period of time.

The fact that real estate investments -- personal residences, investment properties and REITs -- have outperformed the overall returns on growth stocks continues to be a sore point for Wall Street insiders.

"While we like the group's technicals from a long-term perspective, we do see the probability of an up to 15 percent correction over the next six months," said Mark Arbeter of Standard & Poor's Equity Research Services. "The REIT sector's sustained outperformance over the last few years has been based on improving fundamentals. However, we think valuations look stretched on a near-term basis. Although we like the fundamentals long term, we would like to see lower valuations before becoming more bullish on the sector," said Robert McMillan, another S&P analyst.

These comments -- issued in April -- came after many REITs had already reached new 52-week highs, including several local companies.

BioMed Realty Trust (NYSE: BMR) is a Rancho Bernardo company that owns 39 offices and laboratories, including nine properties in San Diego County, that serve the life sciences industry. Since its initial public offering in August 2004 at $15 a share, the stock has been on a tear. It hit an all-time high of $29.86 on March 17. The shares closed Friday at $26.78.

"We continued to be disciplined in our objectives, acquiring properties in our target markets and with acquisition yields above those of traditional office properties, while maintaining a conservative capital structure. Going forward we are well-positioned, having created a highly scalable business," said Alan Gold, the company's CEO.

Those acquisition yields have translated to investor yields. The dividend return at BioMed's current price is 4.30 percent, well above the industry average and nearly double the yield on the S&P 500. Pan Pacific Retail Properties (NYSE: PNP), a Vista REIT that specializes in neighborhood shopping centers, also peaked in mid-March when the share price hit $73.74. It currently trades just below $66 a share.

But the attraction of Pan Pacific for long-term investors has been the attractive dividend. In February, the company raised the quarterly distribution to 64 cents. The annual dividend of $2.56 equates to a dividend yield of 3.80 percent at the current price.

"Since its initial public offering in 1997, the company has increased its dividend each year for a total increase of approximately 76.6 percent, equating to an average dividend increase of approximately 8.5 percent per year," reported Pan Pacific in a news release announcing the dividend hike.

However, the attraction of dividends can quickly fade when interest rates start moving higher. It is no coincidence that BioMed and Pan Pacific share prices peaked at the same time long-term rates started to move up in response to the Federal Reserve's steady increase in short-term rates.

The question REIT investors now face is whether or not the rate hikes are here to stay and, as a result, further declines in stock prices.

"Some REIT observers continue to believe rising long-term rates are a reason to fear the REIT market," said Ken Clift, a fixed income analyst at Charles Schwab.

"Outside of some single-day market shocks, our long-term statistical and historical research has never proven this statement to be true. When we examined 10 years of monthly interest rate and REIT market return data, we concluded that rising long-term rates are statistically insignificant and not necessarily a precursor to falling REIT prices," Clift said.


Send your comments, thoughts or suggestions to george.chamberlin@sddt.com

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