Wednesday, August 25, 2010

The Shaky Foundation Supporting Long-Term REIT Performance

Reprinted by permission from REIT WRAP Special Report dated August 16, 2010.

By David Shulman

Though the first decade of the 21st century has been characterized as “lost” for most equity investors, REITs stood out by generating a 9.75% compound annual return as measured by the total return version of the MSCI U.S. REIT Index (RMS) for the 10- year period ending in July 2010.

This performance is truly remarkable when viewed against the backdrop of a small negative total return for the S&P 500. Moreover after undergoing a near death experience in 2008/2009, REIT investors are once again looking forward to high single-digit returns for the new decade.

However, REIT performance over the last decade did not come from rising earnings and dividends; rather, it came from the tailwind of multiple expansion that is hardly sustainable. Add to that the “meltdown’s” impact (e.g. dilution resulting from massive stock issuance and significant dividend cuts, which helped right-size balance sheets) and the future appears guarded.

Where in 2000 REITs typically traded at FFO multiples in the 6-9 X range, today they trade in the 15-20+ X range. Moreover in 2000, according to data provided by Green Street Advisors, REIT forward AFFO yields were about 700 basis points above the forward earnings yield for the S&P 500; today, REIT forward AFFO yields are nearly 400 basis points below the S&P 500.

In other words, from a valuation perspective REITs are trading at the mirror image of their levels in early 2000 and it is more than likely going forward REIT performance will suffer from the headwind of multiple contraction.


Beneath this stellar REIT performance is a very troubling record with respect to earnings and dividend growth. I dare say that few analysts in 2000 would have forecast the flat to down earnings that most REITs experienced over the past decade. To be sure 2000 represented a cyclical peak in REIT earnings and 2010 represents results around a cyclical trough, but the fact remains that 10 years is a long time.

Let’s get into the data. I examined the earnings and dividend performance for almost all (20) of the equity REITs that are covered by the Value Line Investment Survey. The data excluded those REITs who were bought out during the decade. Nevertheless, I believe it to be a good, though far from perfect sample, in that it leaves out a few of the major mall companies that did well.

I used Value Line because the data is readily available and it presents long term results on a consistent basis. However to be more current, I am using current IBES estimates for 2010 and Zachs Investment Research for future growth rates. The 10 year record for FFO and dividends are presented in a table at the end of this column.

Several of the “blue chip” REITs did well over the decade. The best FFO growth was reported by Public Storage (PSA) where FFO almost doubled and dividends more than doubled. Simon Property Group (SPG), Vornado (VNO), Federal Real Estate Investment Trust (FRT) and HCP (HCP) all reported credible increases in FFO and dividends. Boston Properties (BXP) reported higher FFO but a slightly lower dividend and AvalonBay (AVB) and Washington REIT (WRI) reported modest increases in FFO, but significantly higher dividends. (NOTE: In 2000 FRT, PSA, HCP and for that matter SPG weren’t as highly regarded as they are today. Moreover with respect to BXP and VNO the data ignore the impact of very substantial capital gain distributions made by those two REITs.

On the hand there were many REITs in 2000 that were perceived to be of high quality that faltered during the past decade. Apartment Investment and Management (AIV), Duke Realty’s (DRE), Prologis (PLD) and Developers Diversified (DDR) had their FFO and dividends decline by more than 50%. Such highly regarded REITs as Kimco Realty (KIM) and Equity Residential (EQR) will earn less and pay smaller dividends in 2010 than they did in 2000. The same is true for Weingarten Realty Trust (WRI), UDR (UDR), and BRE Properties (BRE). The mid-Atlantic office companies, Mack-Cali (CLI) and Liberty Property Trust (LRY) are also earning less and paying out less to their shareholders. The same holds true for Healthcare Realty Trust (HR).

In contrast to their short-run low-balling of earnings estimates, sell-side analysts are ever optimistic with respect to long term growth. Going forward analysts believe that REIT FFO growth rates will be in the range of 4-7% for most REITs, save for a few outliers. It may turn out that way, but history is on the side of the skeptics.

To be sure real estate fundamentals might drive REIT earnings higher, but where most analysts miss the mark it is with respect to capital expenditures and adverse changes in capital structure which are inherently difficult to forecast. Remember that the fastest growing REIT in the sample was PSA with a historic growth rate of 6.1%. Among the better performing REITs the growth rates ranged from 5.1% at SPG to 0.7% for AVB. Against the backdrop of the past decade, a seemingly modest 4% growth rate is stellar.

Similarly dividend growth left much to write home about. AVB, FRT, PSA, VNO and WRE reported solid dividend growth -- in the range of 32%-106%. On the other hand dividend payouts were crushed at AIV, DDR, HR, and PLD. This is hardly a record that inspires confidence for the coming decade.

Said differently, for REITs to work in the coming decade, multiples have to remain high and historically optimistic analyst forecasts have to be realized. We do not have the luxury of low multiples to protect us from untoward events.

Figure 1. REIT FFO and Dividend Growth Per Share, 2000 – 2010E

REIT '00 '10 CAGR Est.CAGR '00 '10 %Ch
FFO Dividend

AIV $4.81 $1.28 -12.4% 6.3% $2.80 $ .40 -86%
AVB 3.70 3.97 0.7 6.6 2.24 3.57 59
BRE 2.38 1.87 -2.4 6.1 1.70 1.50 -12
BXP 3.46 4.23 2.0 5.2 2.04 2.00 - 2
DDR 2.19 .86 -8.6 N/A 1.44 .08 -94
DRE 2.46 1.08 -7.9 26 1.64 .68 -59
EQR 2.50 2.16 -1.5 4.9 1.58 1.35 -15
FRT 2.56 3.88 4.2 7.1 1.82 2.64 45
HCP 1.66 2.15 2.6 6.4 1.47 1.86 27
HR 2.62 1.32 -6.6 5.3 2.23 1.20 -46
KIM 1.35 1.11 -1.9 3.0 .91 .64 -30
LRY 3.17 2.65 -1.8 8.7 2.13 1.90 -11
CLI 3.79* 2.79 -3.0* 5.0 2.38 1.80 -24
PLD 2.21 .59 -12.4 34 1.35 .60 -56
PSA 2.59 4.70 6.1 19 1.48 3.05 106
SPG 3.28 5.40 5.1 7.9 2.02 2.40 19
UDR 1.47 1.11 -2.8 4.4 1.07 .73 -32
VNO 3.86 5.17 3.0 10.3 1.97 2.60 32
WRE 1.79 1.97 1.0 1.0 1.23 1.73 41
WRI 1.93 1.66 -1.5 4.6 1.33 1.04 -22


David Shulman was formerly the Senior REIT Analyst at Lehman Brothers. Heis now affiliated with Baruch College, the University of Wisconsin and the UCLA Anderson Forecast. He can be contacted

Saturday, August 14, 2010

Dividend Yields, Bond Yields and Macroeconomic Policy

Last week Aaa rated Johnson & Johnson (JNJ) sold 10 year bonds at a 3.15% yield, well below the 3.71% dividend yield on its common stock. Old codgers like myself remember that stocks in general, with the exception of 1929, invariably yielded more than bonds until mid-1958. After that bonds always yielded more than stocks. As I wrote in my "Paradigm Shift" paper for Salomon Brothers in 1995 the reason for the revaluation of share prices then, in the view of Benjamin Graham, was that macroeconomic policy had the ability to prevent depressions. That view was logically based on policy successes that worked to end the recessions of 1948-9, 1953-4 and 1957-8 with the last one being particularly deep.

What the capital markets are now signalling is that stocks are especially cheap in the light of the past 50 or so years of history or perhaps, more ominously, the markets no longer believe that macroeconomic policy can work in preventing either a depression or a long period of Japanese-like stagnation. In a nutshell, at least for now, it is a vote of no confidence in the Obama Administration and the Fed.

In my own view its a little of both. Stocks are cheap, but the macro environment is extremely troubling. By way of disclosure, my family owns shares in JNJ.