Sunday, July 9, 2017

Reinventing REIT Sell-Side Research

I am beginning to think the current sell-side REIT research model is, if not broken, severely challenged. Simply put, the notion that REITs as a whole belong in an industry group is mistaken. Why? A tax code election, which is what makes a REIT, does not an industry make.  Think about it. Today’s REIT analysts not only cover office, retail, apartment, industrial and hotel properties, they also cover companies that own healthcare, timber, data center, and cell tower assets. 

What senior analyst has the bandwidth to credibly cover all of those industries? I am not saying it can’t be done, but rather it is very difficult. That is why analyst coverage at sell-side firms is largely based on clearly defined industry groups. Furthermore we already see that with mortgage REITs which are usually covered by specialty finance analysts, not traditional REIT analysts.

My suggestion is that instead of covering REITs horizontally, analysts should cover them vertically by their true industry groupings. Thus data center REITs should be covered by computer software analysts, cell towers by telecom analysts, healthcare REITs by healthcare analysts and timber REITs by forest products/paper analysts. In the case of data centers and cell towers, two very hot groups today, I wonder how many REIT analysts have seriously thought through the risks of technological disruption. However let me make this clear, it does not mean the REIT analyst disappears, it just means the individual analyst moves from working in a horizontal REIT group to a vertical industry group where the industry expertise lies.

For example, in the case of healthcare, how many REIT analysts are up to speed on the healthcare reforms now working their way through Washington D.C.? Is any REIT really thinking what the impact of putting Medicaid on a budget, which by the way I believe is inevitable, will have on nursing homes and hospitals? Without a doubt there is more regulatory expertise sitting in the healthcare group than the REIT group. As a personal note, because of the regulatory complexities of covering healthcare REITs and the need to understand what is going on in congressional committee rooms, I never covered those stocks. Life was too short for the brain damage required.

Further I would extend this vertical model into the core food groups of real estate. The revolution now going on in retail makes it essential for retail REITs to be covered by retail analysts. Of course the retail analyst will have to know more about real estate, but the drama is now on the operational side, not the real estate side. Remember real estate is a derived demand. Similarly it would make sense to put the industrial REITs under the transportation/logistics umbrella, office REITs in the business services category, and apartment REITs ought to be covered by housing analysts. In the case of hotels there already is integration between the management companies and real estate owners in many shops. That model seems to work well.

A good example of the model I am suggesting is the boutique firm Zelman & Associates which does an excellent job covering the entire housing complex including single family home builders, apartment REITs, single-family REITs, building materials, building products retailers, real estate brokers and title companies. Why can’t this be done for the REIT industry writ large?

My sense is that with the REIT analyst community doing the same old same old there is very little value being added. Don’t you think it is time to break out of the mold? The buy-side is not going to bite you; they may even welcome the change. If not going all of the way, isn’t it time for further integration and coordination of REIT analysts with the primary industry groups I suggested on the research floor?

1 comment:

  1. Having occupied a position on the ‘buy-side’ over the last couple of years, I concur with your proposition that REIT ‘sell-side’ research offers little value. Today, most Wall St ‘research’ might best be described as being a concierge service related to management access rather than being concerned with providing analytical insights. The sector’s increasing diversity and specialization are certainly big forces of change and I would add indexation and automated trading/lower commissions. Europe’s Mifid II regulations re unbundling/transparency looks like it could be transformative to the industry. The combined weight of Cell Towers and Datacenters in the NAREIT Index now exceeds that of Retail (all public Malls, Shopping Centers and Free Standing companies), which is still, for the moment, the largest sub-sector. You are right that an understanding the demand/supply fundamentals/valuation of many of these new sectors is a challenge for ‘bricks & mortar’ folk that likely exceeds the need for an understanding of the REIT structure for industry specialists. For the moment, REIT capital raising is running at record pace and the presence of somebody/anybody to follow REITs appears to remain supportive. How long can this last?
    Best, David Harris