Reit investors moving from fear to fundamentals

Many real estate investment trusts (Reits) spent the first quarter avoiding a financial funeral, but when they report second-quarter earnings in the next weeks, some may be feeling a new sense of longevity. What a difference $14 billion (Dh51bn) makes.

While the first-quarter earnings season was wracked by fears about who would follow mall owner General Growth Properties into bankruptcy, second-quarter reports will likely be dominated by talk about real estate fundamentals – rent rates and occupancy levels – as well as some hints about moving on and growing.

"I think that initial widespread fears that you're going to have more of these GGP-type blow-ups have left the building," said Andy McCulloch, Senior Analyst, Green Street.

The $14bn Reits raised in massive equity offerings in the second quarter helped strengthen and stabilise Reit balance sheets. The unexpected demand lifted the benchmark MSCI US Reit index from a low of 271.8 in March to 457.04 on Friday, reflecting confidence in the sector's long-term survival.

This earnings season, investors and analysts will be gauging the damage the US recession has inflicted on demand for office space, shopping centres, apartments, and warehouse and distribution centres.

"The things that we're going to be most focused on are occupancy and credit of tenancy and how the companies are going about dealing with these issues," said Robert Gadsden, Portfolio Manager, Alpine Realty Income & Growth Fund.

Some investors and analysts fear that apartment Reits – such as AvalonBay Communities – will see occupancy decline and may lower their forecasts.

Neighbourhood shopping centres, which are anchored by grocery or drug stores, were thought to be recession-proof. But after Regency Centers cut its second-quarter forecast on July 17, some investors see others in the space – including Kimco Realty, Kite Realty Group Trust and Weingarten Realty Investors – as vulnerable. So far, mall giants such as Simon Property Group have resisted granting tenants breaks on their rent.

"I think that's the area that the markets are going to be focused on for the mall group to see whether there's been any cracks that are allowing retailers to get some rent relief," said Gadsden.

For office companies such as SL Green Realty and Mack-Cali Realty, investors want to know how far some core US markets, such as Manhattan, as well as suburban markets have deteriorated. And looking to industrial companies, such as AMB Property, investors are waiting for an update on speculative leases for buildings constructed during the boom. Investors said they believe the Reit sector will reflect continuing deterioration.

"Generally, we're going to be looking for earnings to be down from last year at a weighed average negative growth rate in the five to 10 per cent range," said Jay Leupp, Senior Portfolio Manager for Grubb & Ellis funds.

But deciphering results may be complicated by debt repurchase gains and more shares issued during the equity offerings.

"The earnings this quarter and for the rest of the year are going to have a lot of noise," said Gadsden.

Still, investors expect Reits to continue trimming their leverage levels and bolstering balance sheets.

"Equity is probably not quite as hot a topic as last quarter, but it's still important," said McCulloch. "Now everyone is moving on to phase two of the re-equitisation process. As far as deleveraging, the Reits still have a long way to go."

Reit executives also may try to provide a peek at the more distant future, now that they are more certain they will have one.

"I do think in some sectors we will see some potential rebound in 2010," said Leupp. "There is going to be the potential in some sectors for earnings growth and for firms with healthy enough balance sheets to go on offence and make high-yielding acquisitions that drive earnings growth."

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