Uncertain Future Clouds
REIT Investment Picture

Despite fears of an imminent global recession, there's been some optimism in the commercial real estate sector in the past few months. The conventional wisdom is that investors, wary of slumping equity markets, will seek shelter in the comparatively safe investment haven of bricks and mortar. Falling interest rates also reduce debt levels for real estate investment trusts (REITs) -- publicly traded property portfolios -- and improve overall gearing in the sector. If anything, the Sept. 11 attack on the World Trade Center may hasten that trend, although the long-term implications are still far from clear.

A Tool of Diversification

"Investors are once again focusing on diversification. Both institutional and individual investors are beginning to look at real estate stocks as a tool of diversification, as much as a safe haven. But, since Sept. 11, the level of uncertainty has grown substantially," says Michael Grupe, senior vice president of the National Association of Real Estate Investment Trusts (Nareit) in New York.

REITs recorded phenomenal growth in 2000, with the Nareit composite index soaring 26%. That retreated to around 11% before Sept. 11. Since then, real estate stocks have declined only 3.5%, with several mainly New York-based REITs recording gains on the back of fears of a capacity crisis in Manhattan.

REITs are beginning to attract greater attention from institutions and pension funds. Earlier this year, the City of Dallas allocated 10% of its $2 billion pension fund to real estate, where it previously didn't have an exposure. That was followed in July by two New York pension funds, which added $1 billion of real estate investments to their two funds, which are worth around $25 billion.

The icing on the cake for the $150 billion REIT market would have been gaining admittance to the influential Standard & Poor's 500 Index. A decision on this is imminent and industry insiders are hopeful of gaining admittance. "A listing would be a positive decision and amounts to one more piece of the market acknowledging that the publicly traded real estate business has changed a lot in the past 10 years," says Mr. Grupe of Nareit.

Until now, one of the main reasons for excluding REITs from the index has been that many insurance companies and pension funds already have separate allocations for real estate in their portfolios.

The Benefits of Listing

According to Lee Schalop, a New York-based real estate analyst for Banc of America Securities, an S&P 500 listing would be a significant boost for REITs. "REITs have long been outside the investment universe for many investors. If they are included, there will be lots of direct and indirect benefits," he says.

Nareit has been active in promoting REITs as an increasingly important tool of portfolio diversification, particularly in a bear market. It published research commissioned by Chicago-based Ibbotson Associates in June, which shows that mixed portfolios of equities, bonds and REITs have performed better in the past 30 years than those with no property allocation.

This message is getting through at both the institutional and individual investor level, but analysts say that the improving sentiment toward real estate may be tempered by current uncertainty, which may reduce the number of initial or secondary public offerings this year.

According to one analyst: "Even before this happened, we were not seeing many IPOs this year, but now everything will take longer to do and everyone will want to do an extra amount of homework and that will impact on both primary and secondary offerings."

One of the biggest threats to the sector in the coming months will be the increased costs of bigger insurance premiums and greater security. Coupled with this is the fear that prestige occupiers may no longer want to be based in high-profile downtown buildings that could be potential targets for terrorist attack.

Yet despite all of the forecasting, it may be too early to say how requirements will change in the medium and long term. "It is important that people do not draw too firm a conclusion about what might happen in the future based on the events of Sept. 11," says Mr. Grupe.

-- Mr. Cronin is a free-lance writer based in London.

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