What brought this idea to mind
Was the following article. But the article was only part of the story. one month later this firm UNDERWEIGHTED REITs in model portfolio,large outflows were mentioned in REIT fund reports, Finally WSJ today mentiones Van Guard Windsor fund underperformance witha hint of give up on REITs. KIM largest shopping REIT in country convert pays 7.5%. PLD specializes in unique distribution centers and for you real contrarians just started expanding INTERNATIONALLY.
Investment Highlights:
ú Several months ago we recommended overweighting the REIT sector in a
U.S. equities portfolio.
ú Since then, nothing has occurred which would lead us to question the
premises underlying our recommendation. In fact, recent
underperformance of the last several months has heightened the valuation
logic of our original position.
ú We continue to frame our suggestion in a multi-year context. Regarding
near-term performance, we are not smart enough to anticipate the volatile
mood changes of a stock market which, at least as far as REITs go, may
have lost its linkage to economic fundamentals.
Real Estate Investment Trusts - 10 August 1998
2
Summary and Recommendations
The dramatic underperformance of the REIT sector in
recent months and weeks has raised distress among
investors to new peaks. Year-to-date REITs have
underperformed the S&P 500 by 26 percentage points.
Since our initial "overweight" recommendation on March
20 the group has underperformed by nine percentage
points. Approximately one-half of the underperformance
year-to-date can be attributed to the general
underperformance of mid- and small-cap stocks relative to
the S&P 500.
While we cannot levitate stock prices on our own, we can
provide certain assurances regarding the underlying
fundamentals:
ú Among the companies we cover who have released
quarterly earnings , reported FFO/share for the second
quarter was, on average, almost 13% higher than the
same period a year earlier. In making this and other
calculations in this note, we are using a straight
arithmetic average of the 77 REITs we cover; using an
average weighted by equity market value results in a
higher figure, partially because of the spectacular
historic (but probably unsustainable) growth rates of a
handful of large lodging and office REITs.
Sector and Industry Results Based on 2Q98
2Q97A/ 1997A/ 1998E/ 5 Year Div
2Q98A* 1998E 1999E FFO Gr Yield
Sector
Apartment REITs 13.2% 12.2% 10.8% 9.6% 7.0%
Nghrhd Shopping Ctr. REITs 8.9% 10.3% 12.8% 9.9% 6.8%
Regional Mall REITs 7.3% 6.9% 7.4% 7.3% 8.3%
Factory Outlet REITs 6.7% 9.6% 9.7% 9.3% 8.3%
Health Care REITs -2.6% 6.0% 5.6% 5.8% 7.6%
Office/Industrial REITs 22.2% 19.2% 13.1% 10.3% 6.2%
Self-Storage REITs 8.6% 9.3% 14.4% 9.6% 6.1%
Manufactured Home REITs 10.8% 10.7% 10.7% 10.9% 6.2%
Hotel REITs 25.6% 9.9% 10.5% 9.7% 7.6%
Mixed Use and Misc REITs 28.1% 26.5% 11.9% 9.6% 7.2%
Average 12.9% 12.1% 10.7% 9.2% 7.1%
Based on prices at the market close 8/7/98; RMS = 316.18
E = Merrill Lynch Estimate
*Based on companies reporting second-quarter earnings through 8/10/98
ú Positive earnings surprises have radically outnumbered
negative surprises. We mention this only in the context
of plummeting stock prices during the recent period of
earnings releases. We generally attribute little
significance to modest "surprises" in our sector since
REITs can manage earnings expectations with a high
degree of success. Thus, nobody is really "surprised"
by the surprises.
ú We feel no inclination whatsoever to reduce 1998
estimates based on evidence to date. Thus far, same-store
trends in virtually all property sectors are
somewhat better than we were anticipating. In other
words, current real estate occupancy and rent trends are
moderately exceeding our earlier expectations. Our
estimate of earnings growth this year over last year
averages 12%; again this number would be higher on a
market value weighted basis.
ú Our estimated average five-year growth rate for
companies we cover is 9.2% (with 1998 as our base
year). For the most part, we have assumed that REITs
are shut out of the equity market through year-end
1999. Ironically, the impact of the no-equity issuance
assumption may be to raise rather than lower 1999
estimates since debt financing is nominally cheaper
than equity financing.
ú If REITs were shut out of the equity markets
forever, our earnings models would probably bring
our average five-year growth rate down a
percentage point or so to a little over 8.0%.
Essentially, the components here would be (1) 4%
to 5% internal FFO growth (resulting from 3% to
4% unleveraged same-store NOI growth); (2) 2%
from cash flow retention (the difference between a
7% dividend yield and a 9% AFFO yield); (3) 1%
or 2% from some combination of development and
acquisitions funded either through property sales,
joint ventures, or a modest increase in leverage.
ú The arithmetic mean dividend yield of the
companies we follow is 7.1%; weighted by market
cap, that figure is 6.5%. Adding the dividend yield
to a growth rate of 8% results in a sum of
approximately 15%. Usually, we are reluctant to
forecast total returns by simplistically adding
dividend yields to growth rates because doing so
requires assuming simplistically that a company's
earnings multiple remains constant. In today's
environment, however, with most of the companies
we follow trading below net asset value (NAV), we
view the constant-multiple assumption as
conservative. In other words, we very much expect
a five-year annualized rate of return from the REIT
sector in the mid-teens, and possibly higher if we
experience an upward revaluation of the group.
ú The obvious fly in the ointment to this scenario -
apart from a recession which we believe would
impact S&P earnings far more severely than REIT
earnings - would be significant overbuilding.
While we are not Pollyannas about the risks of
overbuilding, we do not see a debacle on the
horizon. In the apartment market, our research
shows that the sector is generally in equilibrium,
with the number of markets that are getting tighter
slightly outnumbering the number of markets that
are getting weaker. In retail, new space is
continually displacing obsolescent space, but the
rate of new construction is holding steady. In
industrial markets, new supply is being easily
absorbed by new demand. In the office sector, new
supply is certainly increasing, but there is little
evidence yet that a pervasive overbuilding boom is
in the offing (for more detail, see our report
published this morning entitled "Tracking Major
Office Markets in the U.S."). Finally, in the hotel
sector, our research confirms the general impression
that limited service supply is booming, full service
construction is moderate, and that, in the aggregate,
occupancy rates should slip by no more than several
percentage points over the next two years.
ú On March 20 of this year, we recommended
radically overweighting the REIT sector. While the
recommendation was placed in a multi-year
context, we are still unhappy about the fact that
REITs have underperformed the S&P 500 by nine
percentage points since then (the group had
underperformed by 17 percentage points year-to-date
prior to our March 20 recommendation).
Nevertheless, nothing has occurred which would
lead us to question the premises underlying our
recommendation. If anything, the continuing
underperformance of the last several months has
heightened the valuation logic of our original
position. Thus, we continue our "overweight"
position, although we reiterate this suggestion in a
multi-year context. Regarding near-term
performance, we are not smart enough to anticipate
the volatile mood changes of a stock market which,
at least as far as REITs go, may have lost its linkage
to economic fundamentals.
[RA] MLPF&S or one of its affiliates was a manager of the most recent offering of securities of this company within the last three years.
[PLD, PAH, HOT, EQR, PPS, DDR, KIM, BXP, CEI, EOP, HIW] MLPF&S was a manager of the most recent public offering of securities o f this company within the last three years.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1998 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
regulated by SFA, and has been considered and issued in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law. The information herein was
obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available.
Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments").
MLPF&S and its affiliates may trade for their own accounts as odd-lot dealer, market maker, block positioner, specialist and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side
of public orders. MLPF&S, its affiliates, directors, officers, employees and employee benefit programs may have a long or short position in any securities of this issuer(s) or in related investments. MLPF&S or its affiliates may from
time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report.
This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person
who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that
statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive
back less than originally invested. Past performance is not necessarily a guide to future performance.
Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced
by the currency of the underlying security, effectively assume currency risk. |
