Calling Room Service
Hotels offer a third and also different relationship to the broader economic picture. "In 2010 and early 2011, as the economy started to rebound, hotel REITs were strong," NAREIT's Grupe says. Then, as the economic outlook weakened in the third quarter of 2011, people started canceling vacation plans, and businesses started reconsidering whether they had to travel for in-person meetings when they could talk on the phone, and hotels were hurt. Now with the economy looking better again, hotels are looking better.
Hotels also have the advantage that when the market situation improves for them, they can change their rental rates by the day, where apartments are usually locked into one-year leases, and commercial property leases can run for years.
REITs, at least when you're investing in individual companies, also have to be analyzed in terms of their demographics and even their geographics. "Office buildings are doing great in San Francisco," says John Cheigh, portfolio manager for Cohen & Steers, a fund manager that focuses on U.S. and global real estate investments. "They're doing great because tech companies are doing great and need more office space."
The same holds true, Cheigh says, for office REITs with holdings in West Los Angeles, Cambridge and Boston. "Even in New York," he says, "it's the new economy—knowledge workers, technology and biotech companies, etc., that are the driver, not finance or lawyers."
Don't expect REITs to repeat some of the stellar performances of 2009-2011, most analysts say. Even Ron Kuykendahl, the media spokesman for NAREIT, the industry trade group, while pointing to the industry's hot first quarter this year, suggests that the industry may have a tough time following up on its prior big years. He looks for a lot of acquisition activity, noting that there are a lot of distressed properties available, and that many REITs boast strong balance sheets.
In general, real estate is a lagging indicator, says Marc Halle, a senior managing director at Prudential Investors. "If you see significant job growth, that will lead to more demand for office space and to more business in the shopping malls." In turn, he suggests, investors will anticipate higher income for office REITs and shopping mall REITs, leading to higher share prices and, if that higher income materializes, to higher yields, too.
Philip Martin, a REIT analyst with Morningstar, says that overall, REITs are currently trading at about a 15% premium to fair value in Morningstar's opinion, when dividends are included. Share prices are being supported, he adds, by bond investors and by baby boomers who are nearing retirement, with both these groups looking for income-generating investments at a time when interest rates are generally low.
For his part, Martin says he currently likes health care REITs. "I like that they are less cyclical. They have stable income streams and they have high yields, and should be able to increase dividends," he says. "If someone has a three to five-year time horizon, we try to look for quality companies that can not only sustain but grow their dividends, because we think that we will over that time be seeing rising interest rates and increased inflation."
REITs that Martin likes are Alexandria Real Estate Equities Inc. (ARE), Senior Housing Properties Trust (SNH), Taubman Centers Inc. (TCO) and AvalonBay Communities (AVB).
Alexandria focuses on the laboratory space market as a subset of the health care industry, Martin says. "Their dividend is at the low end, but they have a healthy and improving balance sheet and a very high quality portfolio of properties." This REIT, Martin says, is currently trading in the $71 to $72 range, while Morningstar is valuing it at $87.
Senior Housing Properties, which is also in the health sector, is a REIT that owns and leases nursing homes in 38 states. Currently a hold, not a buy, according to Martin, the stock is trading at $22, but has a Morningstar fair value estimate of $28.
Martin also likes Taubman Centers, a retail mall REIT. While high-end malls catering to wealthier consumers have been faring well, Martin says that the REITs that specialize in such tonier properties are already too expensive.
Taubman, on the other hand, is focused on grocery-centered shopping centers that tend to be located in high growth markets near urban centers, "where there is little development risk." He says, "These are need-driven malls, not luxury malls." Taubman, he argues, "has a solid business model, though at the moment they're trading at a pretty fair premium."
While the multifamily apartment REIT sector has probably had its run, and is generally looking pricey, Martin says he likes AvalonBay Communities, because of its demographics.