Analysts Are Predicting
Low Returns for REITs

Two more analysts are predicting flat to low returns for real estate investment trusts in 2005.

J.P. Morgan analyst Tony Paolone is projecting flat returns this year, although he believes there will be volatility in getting there.

Paolone expects funds from operations to rise 7% in 2005 and for dividends to increase about 3% to 4%. However, the FFO growth will be offset by investors pulling out of the sector.

"REIT valuations are near all-time highs, the dividend yield spread relative to the 10-year Treasury is only 80 basis points, and this rather defensive industry has handily outperformed the S&P 500 in each of the past five years," Paolone said in a note. "We believe capital flows will rule the day once again in 2005, and it is tough for us to see how this benefits REITs."

Banc of America Securities analyst Ross Nussbaum is predicting 3% total returns in 2005, with dividends being the key driver. He favors industrial and self-storage REITs - such as ProLogis (PLD), Catellus Development Corp. REIT (CDX) and Public Storage Inc. (PSA); office REITs that have a New York or Southern California focus - such as SL Green Realty Corp. (SLG), Brookfield Properties Corp. (BPO), and Maguire Properties Inc. (MPG); and high-profile retail REITs - such as Simon Property Group Inc. (SPG) and Kimco Realty Corp. (KIM).

Nussbaum does not own shares of the companies mentioned, but his firm has had investment-banking relationships with ProLogis, SL Green, Brookfield, Maguire, Simon and Kimco.

Paolone said hotel, office, apartment and industrial REITs were hit hardest during the recession and therefore stand to benefit from accelerated earnings growth in 2005 and 2006. Defensive property types, such as net lease and retail REITs, that held their own during the downturn could have a tougher time attracting capital as their growth rates may not have as much upside in the recovery, he said.

In the first 12 days of 2005, the Morgan Stanley REIT index fell 7.4%. Nussbaum speculates the selloff was likely triggered by profit-taking and interest rate fears. He expects REITs will find a floor during the earnings season and possibly rebound in February and March as positive earnings reports come out.

Both Paolone and Nussbaum are expecting a roller-coaster ride for REITs in 2005, though. "While we implicitly assume that stock prices at year-end will be close to where they are now, we hardly assume it will be a straight line getting there," said Paolone.

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