Ninety-nine percent of the failures come from people who have the habit of making excuses.
George Washington Carver
Real-estate investment trusts posted negative returns in the third quarter and continued to trail the broader stock market, raising the prospect that the sector is losing its luster in the eyes of investors.
The Dow Jones Equity All REIT Total Return index, which tracks 147 publicly traded REITs, delivered a total return of minus-2.7% in the July-September period, its worst performance since the third quarter of 2011. By comparison, on a total return basis, the S&P 500 index gained 5.2% in the third quarter and 2.9% in the second quarter.
“We’re in the second quarter of blah returns, and I think there certainly could be more of this funk going forward,” said Larry Raiman, chief executive of LDR Capital Management who runs a $180 million REIT fund. “Based on what investors seem to be telling us, they still think [interest] rates are going up. The REIT equities are not poised for any substantial rebound.”
Economists and analysts say much of the malaise can be traced back to May, when Federal Reserve Chairman Ben Bernanke signaled that the Fed could begin to pull back on its program of buying mortgage bonds and Treasury securities later this year. The announcement caused the yield on 10-year Treasury notes to jump nearly a full percentage point, which in turn has resulted in a sharp rise in interest rates in general.
REITs, which pay little or no corporate income tax and usually pay steep dividends, are sensitive to rising interest rates because they depend on borrowed money to expand their businesses.
As a result, when borrowing costs rise, REITs get dinged twice: their cost of capital goes up, and their dividend payments become less appealing compared with other high-yielding investments. The average dividend yield for the Dow Jones REIT index stood at 3.78% for the third quarter, up from 3.52% the previous quarter and 3.38% a year earlier.
“There was a time when people were overly exuberant about how long interest rates were going to stay low. That time is gone,” said Jason Yablon, a portfolio manager with Cohen & Steers, one of the largest U.S. REIT investors.
Investors have shied away from real-estate stocks even as broader equity markets have gained. Since rates began to rise this spring, fund flows to North American real-estate-industry mutual funds, excluding exchange-traded funds, have turned negative. Investors have pulled $728 million out of such funds since the week of May 15, while flows to all equity funds were $42.8 billion over the same period, according to Lipper data analyzed by Evercore Group.
According to the National Association of Real Estate Investment Trusts, REIT stocks have underperformed the S&P 500 stock index in each of the past four months. In the past four full years, REITs significantly outperformed the broader market.
Analysts point out that the best-performing REITs in the third quarter were those that make money by renting properties with short-term leases. Frequent lease renewals allow these landlords to raise rents to compensate for the rising cost of borrowing that comes with rising interest rates.
Landlords that sign tenants to longer-term leases, such as owners of health-care facilities, tend to suffer most when rates rise quickly, because they are locked in to long-term agreements and can’t quickly raise rates.
“We’ve been very cautions and we’re staying away from long-term leases,” said Ryan Dobratz, co-manager of the Third Avenue Real Estate Value Fund, a $2.1 billion fund that invests in REITs and real-estate operating companies.
Self-storage REITs, which delivered a total return of 7.45%, and hotel REITs, which returned 6.23%, were the only subsectors to post gains in the third quarter. “Self-storage was always regarded as the ugly stepchild of the real-estate industry, but our industry was always thought to be recession-resilient,” said Spencer Kirk, chief executive of Extra Space Storage Inc., which delivered a total return of 9.1% in the third quarter.
“What we have right now is a lot of uncertainty, so investors may be hesitant to make moves,” said Calvin Schnure, an economist with the National Association of Real Estate Investment Trusts. “But the fundamentals are definitely on the side of the REIT industry.”
A version of this article appeared October 9, 2013, on page C12 in the U.S. edition of The Wall Street Journal, with the headline: Investors Turn Away From Once-Hot REITs.
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I am a successful Commercial Investment Real Estate Broker in Arizona now for 15 years and I worked with banks and their commercial REO properties for 3 years. I am also a commercial landspecialist in Phoenix and a Landspecialist in Arizona.
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