REITs On Comeback
But Earnings Loom

Many investors abandoned real-estate investment trusts earlier this year, but they are slowly beginning to bet on them again as commercial real estate continues to boast solid fundamentals.

Still, as third-quarter earnings reports kick off next week, analysts and investors wonder what impact the recent credit crunch and a possible slowing economy could have on these companies.

REITs, which are publicly traded companies that pay out at least 90% of their earnings in dividends, hit a speedbump during 2007 after several years of outperforming the Standard & Poor's 500-stock index. From Feb. 7 through Aug. 15, total returns for the equity REITs plunged 25.3% according to SNL Financial. Many investors believed the good times were over for REITs and fled, partly because they feared that the subprime mortgage woes that were crippling the residential market would spill over to the commercial side. (See related story.)

Equity REITS are down 3.78% year to date, according to SNL Financial. But since their August low point, REITs have rallied, outperforming the S&P 500. The more recent pickup was mostly sparked by the Federal Reserve's recent cut in the federal-funds rate by one-half of a percentage point to 4.75%. Since that point, "the REITs have been the comeback kids," says David Harris, a REIT analyst at Lehman Brothers Holdings Inc.

Some REIT sectors bounced back more than others during the third quarter. The health-care REITs performed the best, with total returns up 11%. One reason: Investors bet on the need for assisted living facilities for years to come, thanks to the steadily growing demographic of affluent seniors.

Hotel REITs, on the other hand, had the worst performance of the quarter, with total returns down 4.69%, according to SNL Financial. Analysts say these REITs were coming off a period of tremendous performance after a number of these companies agreed to be taken private earlier this year.

Some analysts are turning negative on the office sector. Green Street Advisors, a real-estate research firm based in Newport Beach, Calif., wrote in a recent note that "the party is over" for sky-high private market values in this sector. That's because borrowing costs are higher, which has resulted in a slowing of transactions and a softer pricing environment.

But even as real-estate values are starting to decline, many investors are starting to take a look at the entire REIT universe again. They see that many of the companies trade at a discount to their net asset value, a key measure of the underlying worth of the company's real estate value, and therefore represent good deals. They were also encouraged by the REITs' continued access to capital throughout the recent credit crunch.

And, operating fundamentals have remained reasonably solid across most property sectors, says UBS AG REIT analyst Jeffrey Spector. Overall, supply in most markets appears in check, occupancy rates remain high, and rent growth, while slowing in some sectors, is still strong. Same-store net operating income growth, an important measure of a property group's profitability, is still positive.

Right now, "it's still a good time to be a landlord," says Michael Torres, chief executive of real-estate investment firm Adelante Capital Management in Oakland, Calif.

Another sign of investor confidence is a slowdown in the mutual-funds money flowing out of REITs. Last week, the four-week moving average for fund flows exiting the REITs was $267 million, compared with $349 million the week before, say UBS analysts.

There seems to be a lot of anticipation surrounding third-quarter earnings from analysts and investors. One reason is pretty standard: The third quarter is just closer to the time when full-year numbers are disclosed, which will start in early January. If management has to adjust its guidance higher or lower, they tend to do so at this time, says BMO Capital Markets analyst Paul Adornato.

But analysts and investors will also have their eyes on several others things during the earnings season. As some REITs have been completely shut out of the acquisitions game over the past few years because of private-equity domination, many will be looking to see if companies are ready to make transactions again.

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