Anyone know of some "good" 2nd grade Office/Retail REITs
that is prime for shorting?
This may be useful:
quote.yahoo.com
from grantsinvestor.com
Bucking industry optimism, we see the office real estate
market poised on the edge of a slippery slope. Sell REITs
and buy a CD, instead.
It's a stock pickers' market . . . in real estate. At least that
was the near-universal assessment of presenters at the first
annual Reis.com real estate conference a few weeks back.
Although all speakers acknowledged the forbidding
macroeconomic environment, each professed guarded optimism
about select real estate investment opportunities. For our
part, we found the disconcerting macro observations far more
persuasive than the
really-smart-guys-can-still-make-9%-per-year argument.
Whatever opportunity may exist for the stock picker, the
trend will be no friend. Net-net, we would be sellers of almost
all REITs, especially those focused on trendy, high-priced
markets like San Francisco, Boston, New York and Atlanta. A
few of the names that come to mind are CarrAmerica (CRE),
Cousins Properties (CUZ) and Boston Properties (BXP).
The Reis confab was a terrific conference put on by a bunch of
terrific guys who produce absolutely terrific research.
However, the office real estate investment outlook seems
anything but terrific. Glenn L. Lowenstein, founding partner of
Lowenstein-Romo Capital, a national real estate investment
firm, served up some of the day's most enlightening
observations. Despite giving a mostly upbeat prognosis for
office real estate investment, Lowenstein observed that
"every market is building one too many buildings." As a
consequence, he continued, "If Silicon Valley is a 2% vacancy
rate now, it's going to be 6% to 7% within a couple of years."
In such an environment, Lowenstein thinks it will be a lot
easier "to be a lender than an equity guy." (We suspect it will
not be so easy to be a lender guy, either.)
The day's keynote speaker, real estate mogul Sam Zell,
sounded a similarly cautious note. But he proclaimed
nonetheless, "I remain an optimist." (Zell wasted no time
putting his money where his mouth is. Just over four weeks
after the conference, Equity Office Properties Trust (EOP),
of which Zell is Chairman, bid over $7 billion, in cash, stock
and assumed debt for Spieker Properties (SPK).)
Chalk up one particularly noteworthy vote for the bulls. Still,
we'd cast our one insignificant little vote with the bears. The
main problem from an investment perspective is that the
office property market has never been in better shape, and
the office REIT stocks amply reflect the good news. In other
words, the path of least resistance appears to be pointing
south. At the very least, this ain't the bottom. Consider the
following highlights from Legg Mason's "Real Estate
Securities Quarterly":
-- The average portfolio occupany rate for the office REIT
industry notched a record 96.1% as of last September 30.
-- Over the past four years, industry leaders like BXP, EOP
and SPK all registered better then 14% annualized growth in
funds from operations (FFO).
-- Vacancy rates in the national office market have stabilized
at 8.1%, the lowest level in 20 years.
-- The United States absorbed more office space in the 12
months ended June 30, 2000, than in any 12-month period in
history.
Over the last 12 to 18 months, office REIT investors have
enjoyed a considerable tailwind generated by four favorable
trends: (1) A booming economy; (2) a dot.com bubble overlaid
on a booming economy; (3) falling interest rates; (4) falling
REIT yields relative to Treasurys. Can this perfect world
continue? Seems like a big bet just to capture a 6% yield,
particulary when this scenario is vulnerable on all fronts.
Grant's Investor is not the first to raise the possibility that
the U.S. economy might deviate from the "V-bottom" story
line scripted by Alan Greenspan. A protracted slowdown would
no doubt produce much higher vacancy rates and much lower
rents than REIT operators currently anticipate. No less acute
for being obvious, this cyclical risk seems ignored by many
REIT shareholders. By our calculations, most office REITs
are more likely than not to fall short of the Street's
consensus revenue and FFO targets for 2001 and beyond.
The deflating dot.com phenomenon also presents a unique risk
to office REITs. Moody's Investors Service examined the
dot.com dark side last month in its "Office REIT Industry
Review." With characteristic understatement, Moody's
observed: "Some of the biggest challenges facing the office
sector include the technology effect and unsustainable rental
rate increases. We anticipate further fall-out from the
technology sector, which will result in supply being returned to
market." The report continued: "There's more sublease space
coming on the marketplace. And it's not just from dot.coms,
but is coming from all the 'camp followers' -- the folks who
service dot.coms. You have the lawyers, the accountants, and
consultants. So, when looking at the effect of a dot.com
downdraft, you have to look beyond just the immediate
tenants to include the 'service' tenants, too. Again, these
folks tend to be users of class A or B-plus office space,
generally central business district. So, there is more coming
back on the market, and we think there will be more still."
REIT shares also face interest-rate risk, both absolute and
relative to competing yields. First, the absolute risk: As
"dividend stocks," REITs have rallied right along with the
Treasury market. Since the 10-year Treasury registered its
recent high yield of 6.56% last May 8, the yield has declined
an eye-popping 173 basis points. Is it any wonder then that the
Bloomberg Office REIT index produced a 12.5% total return
over the same time span, even as the Nasdaq was plunging
45%? But what if yields on 10-year Treasurys returned to
6.5%? It's been known to happen, especially when inflation is
heating up. Under such a scenario, office REITs would bestow
more sorrow than succor.
Additionally, office REITs are vulnerable at present because,
relative to Treasurys, they have rarely offered such low
yields. For example, CRE currently yields 147 basis points
over the 10-year Treasury bond. But in the midst of the 1998
Long-Term Capital Management crisis, when a recession
appeared to be dead ahead, the stock yielded a fat 405 basis
points over the 10-year Treasury. Office REIT investors
seem more sanguine this time around, despite the gloomy
economic news. The optimism may not last, however. Even if
interest rates hold relatively steady, rising anxiety in the
REIT sector could precipitate a sell-off, driving relative
yields up toward their 1998 highs (or lows in price). Such a
regression would shave about 30% off the CRE share price.
In short, the world need only become a little less perfect to
transform office REITs into poor performers over the next
year or so. At current prices, office REITs offer the dubious
allure of junk bonds at par -- all the downside of equity
coupled with all the upside of current yield. Buy a CD. |
