October 20, 2015
Investors, shaken by the sell-off in the broader market, are frantically seeking refuge in companies offering buybacks, high dividend yields — anything that can stop the bleeding in their portfolios. And certain real estate investment trusts are quickly becoming an attractive option.
A report released recently by Fitch Ratings shows a surge in the number of REITs planning stock buybacks through the remainder of 2015 and into 2016 to prop up their beaten-down prices. During second-quarter earnings conference calls, at least 28 REITs discussed plans to repurchase shares.
“The companies are signaling there’s a big disconnect between the current valuation in the public market and where private market real estate values are,” said Thomas Bohjalian, an executive vice president at Cohen & Steers, which holds shares in REITs.
Commercial real estate fundamentals — such as demand, occupancy and rents — remain strong, which has kept property values up in the private market, said Steven Marks, a managing director at Fitch Ratings who specializes in United States REITs.
“The private market is valuing real estate assets more highly than Wall Street is — which is why companies are buying back their own stock,” he said.
REITs currently trade at a 15 to 20 percent discount on average to the value of their underlying properties, according to Michael Knott, a managing director at Green Street Advisors, a REIT research and advisory firm in Newport Beach, Calif.
“That’s one of the widest discounts we’ve seen over the last 25 years,” Mr. Knott said.
One segment, mall REITs, is experiencing even sharper discounts of 26 percent on average, he said.
At the same time, REITs, by their nature, offer higher-than-average dividend yields. Under REIT rules, companies must distribute at least 90 percent of their taxable income to shareholders as dividends to avoid paying most corporate taxes.
The average REIT dividend at the end of September was 4.4 percent, according to the National Association of Real Estate Investment Trusts. Certain sectors of the REIT universe offer even loftier yields, such as health care REITs, whose dividend yields average 5.8 percent, and mortgage REITs, whose yields average a whopping 11.6 percent.
Together, the buyback program and dividend yields make REITs a tempting alternative for investors looking for a breather from the market’s roller coaster ride.
“The U.S. REITs are now trading at double-digit discounts to NAV” — net asset value — “and have pretty attractive yields relative to the broader market and to fixed income,” said Ritson Ferguson, chief executive of CBRE’s Clarion Securities unit, which holds shares in REITs. “This looks attractive to me, especially since the underlying business is quite good.”
In theory, it sounds like a no-brainer: Jittery investors could park cash in REITs, enjoy stock price gains from the buybacks, and collect a hefty dividend while riding out the geopolitical storm.
“To the extent that someone is looking at a cheap entry point into owning good real estate, this is a very good time,” said Anthony Paolone, an executive director at JPMorgan Chase.
But REITs, like other investments, come with risk. And experts caution investors not to blindly jump into those that promise the biggest buybacks or the frothiest yields.
Investors need to scrutinize an individual REIT’s debt level, cash flow and credit rating to ensure that a buyback program will not push a company’s leverage — debt and preferred stock — into dangerous territory and that its dividend is not at risk of being cut. The best picks are those that trade at discounts of at least 20 percent, have leverage under 40 percent, have investment-grade ratings and plan to sell properties to pay for a buyback program rather than borrow.
Mr. Knott of Green Street Advisors is keen on high-end mall REITs, such as Simon Property Group and Taubman Centers. Both trade at big discounts and have aggressively bought back shares.
Analysts also like Host Hotels & Resorts and CBL & Associates Properties, a retailing REIT. When they announced buyback programs, Host was trading at a 25 percent discount to net asset value, and CBL was trading at a 30 percent discount.
On the other hand, experts questioned Brandywine Realty Trust’s buyback program. Brandywine, an office REIT that unveiled a $100 million buyback program in July, already has high leverage and a rating below investment grade, which could worsen with the buyback, Mr. Marks of Fitch Ratings said.
Then there is the risk from rising interest rates. “REITs are perceived as interest rate sensitive,” Mr. Knott said. Investors dumped REIT shares over the last few quarters over concerns about when — and by how much — the Federal Reserve will raise rates. REIT total returns, which include dividends, are off 6.3 percent through the end of September 2015.
REITs constantly need access to cheap money to acquire and develop properties in order to grow. In general, rising rates mean higher borrowing costs, which can cut into a REIT’s profits and valuation.
Also, as rates rise, those sparkling REIT dividend yields will not look as shiny anymore as the spread between REITs and bonds tightens. “REIT equities are viewed primarily as yield investments, and so as interest rates rise, the attractiveness of the REIT dividend yield goes down,” Mr. Marks said.
But analysts say Fed rate increases, when they do come, will be slower and smaller than in past cycles, given the sluggish United States economic recovery, low oil prices and uncertainty in China. They most likely will not have a material impact on REITs.
Some experts contend the rate risk is overblown and REITs have been oversold.
“It’s already been baked into REIT pricing,” said Mr. Ferguson at Clarion Securities. “That’s why this buying opportunity has opened up.” He added that REITs are on track to generate earnings growth of 7 percent on average in 2015 on top of the 4 percent dividend yield: “That’s a pretty nice total return prospect.”