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A commenter had a smart thought on REITs and why they have outperformed the benchmark indices. Be sure to check it out here.

I’m sure that the commenter knows that they are talking about, but I do have one quibble. The notion that REITs should be doing well because they have a future opportunity to buy distressed real estate does not make sense. Or if maybe I should say that equities investors should not rely on that potential opportunity in assigning value to stocks. First, it’s only a potential opportunity. REITs may be buying at prices lower than they have in years, but they will in fact be market prices established through competitive bid. Second, REITs will have competition in the way of privately held companies that will bid for the same assets. So I think the idea of assigning value to a company based on what they might in the future acquire (that everybody else in the market might also acquire) is sort of silly.

But the point I make above is sort of a side note. The real reason I disagree that the opportunity to acquire distressed assets should be positively reflected in a company’s current valuation is because the new acquisitions will make up a small portion of the company’s overall holdings. However, it’s not just that the “value” portion of your portfolio is going to be a small part of your future holdings. It’s that it has implications for the rest of your portfolio. REITs are overwhelmingly going to be owners/sellers because they already have significant holdings. So if the new assets that they acquire have an implied cap rate at a 200bps spread over the average acquisition cap of their current portfolio, guess what the new implied cap rate of their existing portfolio is? It does not work to say “All of our existing holdings have X value. Everything that we will be buying will be for 3/4 of X. The new price (3/4 of X) that we will be paying does not impact the value of our existing holdings, which are still worth X.”

There is some truth to the notion that companies that can access corporate debt, and not have to rely on single asset debt, can prolong the day of reckoning. I suppose that does offer some kind of market advantage. We’ve seen the public homebuilders pull off this trick. But eventually everybody has to pay the piper.

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January 14th, 2010 | Category: Uncategorized | 5 comments

Viewing 5 Comments

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    i have a couple with this. first, to john, if a investor (of any type) is able to acquire distressed assets or debts that necessarily implies a discount to market pricing due to dealing with the risk of a distressed situation. so, i dont disagree with your statements, but the reality is you can buy deals at X CAP and then by distressed (discounted) assets at a positive spread and that will not negatively impact your holdings. now, where you absolutely right is that plenty of reits have SEC filings stating that their book value of a property is 6.5% CAP while the broader market is 7% CAP. now, im no rocket scientist, but that doesnt make a ton of sense. why does every reit have a portfolio superior to the market? but, that gets into all kinds of details that are boring to type about.

    to T, last time i checked the first two words in reit were real estate. the purpose is to allow individual investors access to institutional quality diversified portfolios without direct real estate exposure. the NAV of the assets IS the value of the company. anytime that multiple rises above 1.0x it means that the company has significant earnings potential in the direct future. that can be done via acqusitions or improved property operations/noi growth. but what we see today is reits trading at multiple of their yeilds - capitalizing on the capitalization - and that makes ZERO sense. i do agree that the growth and follow-ons weve seen have basically been the rebound from an overreaction to the CRE doom. but that doesnt mean they make any sense. retails sales were 5.5% better than last year, yet mall reits are up 60%. that does not compute.

    lets call a spade a spade. most reits are trading at multiples during a period in which they should be trading based on yield. recovery or not, the future earnings are priced into reit values. so traders are making a big bet that the recovery will boost stocks to the current valuation levels. this is indicative of the market as a whole, though. so, trade up, trade up, trade up, until it suddenly corrects. then do it again.
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    Not every REIT has a portfolio superior to the market but in general, REITs do own higher quality assets. Take GGP and Simon for example. Think of the nicest mall(s) in your area and one of those two REITs will most likely own them. This is not to say that they haven't experienced their share of pain but they also benefit from "flight to quality."

    All in all, I think we can all agree that nothing makes a whole lot of sense right now. It's best that everyone just tries to take full advantage of it.
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    I didn't mean to imply that the potential acquisiton opportunities can largely explain the market performance of some of these REIT stocks. It does however play a role since many of the large REITs have been open about their acquisition appetite and have made some, albeit, smaller acquisitions. For valuing a REIT stock it's not about the cap rate, it's about the earnings growth per share and dividend yield. If a REIT can still make investments that are accretive to earnings then that will drive their valuation even if the cap rates on the new acquisitions are Xbps above their legacy portfolio.

    Like I said, a lot of the performance is recovery performance from being beaten down so far and then driven by deleveraging events that took place. Performance in 2010 will come from slightly improved fundamentals (depending on sector) and investment opportunities.
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    Thanks for the thoughtful comments. I won't play a game of "I got the last word here", but I do have one more minor point to make. REITs can be essentially boiled down to what they own and what those assets produce in the way of income. While it's true that their stock prices will be based on the earnings growth and dividend, it's also true that it's difficult to separate out their earnings from the earnings of their assets. REITs are essentially the public markets response to essentially securitizing ownership of real estate.
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    It's an interesting model for sure with a lot of benefits, especially in times like now. It also doesn't hurt that some companies have non-recourse mortgage debt so they can literally just hand over the keys when they don't like the assets anymore (see Sunstone).

    Looking at NAV is where the asset values start to bite the REIT but fortunately that's not what they are mainly valued on (most are now trading at a premium to NAV, rather than the big discounts seen early last year).

    By the way, I like the site. One of my main reads everyday.
 
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