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Sunday, September 5, 2010 |
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| REITs Look to Return to Their Retail Roots |
By ANTON TROIANOVSKI |
WALL STREET JOURNAL |
January 6, 2010
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The fast-money crowd has been moving more heavily into real-estate investment trusts, replacing small-time investors as the industry's major shareholders. But companies are vowing to win back the little guy.
At the end of 2009, more than 80% of REIT shares were held by institutional investors and company insiders, according to an analysis by research firm FactSet Research Systems Inc. That is up sharply from 10 years ago when institutions and insiders owned 40% of all REIT shares and individual investors owned the rest. While individual, or retail, ownership of REITs ticked up slightly in 2009, many in the industry worry that legions of small investors will begin selling again.
"Four trillion dollars are basically going to vote with their feet," said Michael Hudgins, a REIT strategist for J.P. Morgan Asset Management, referring to money in employer-based retirement accounts. People saving for retirement used to be drawn to REITs because of high, steady returns. "They're either going to come into this asset class or they're going to leave it."
The reason for diminished interest in REITs among individual investors can be summed up in two words: volatility and dividends. For years, REITs paid hefty cash dividends, with the annual yield averaging 7.4% from 1990 to 2002. By the end of 2009, the yield was 3.7%.
Even though REITs are required to pay out 90% of their income to shareholders, the companies received permission during the financial crisis to distribute part of the dividend in stock instead of cash in order to conserve capital. The REITs that took advantage of the ruling infuriated investors who were counting on cash dividends from their shares. The government recently allowed REITs to do the same thing again this year.
At the same time, REIT stock prices have gyrated. The Dow Jones Equity All REIT Index swung more than 5% in a single day only three times from its inception in 1990 to the end of 2007. From September 2008 to March 2009, that happened 64 times.
REITs took on more debt during the boom as they pursued riskier strategies, leaving them exposed to the financial crisis. As volatility increased, traders flooded into the REIT market, using exchange-traded funds to move in and out of the stocks quickly and exacerbating the day-to-day swings, analysts and executives say.
Falling dividends and rising volatility have left individual investors shellshocked. Randy Beeman, an investment adviser in suburban Washington, who oversees $1.7 billion in assets for 2,000 clients, invested about 15% of his clients' assets in REITs as recently as 2006. He thought of the shares as securities that were less volatile than stocks and generated a big, steady yield, like bonds. But Mr. Beeman began moving his clients out of REITs in 2007 and continued to do so as dividends got cut. Now, Mr. Beeman devotes just 5% of an average client's portfolio to REITs.
"I think at some point I will be comfortable adding more than that, but not just yet," says Mr. Beeman, who also hosts a Washington-area radio show about investing. He wants to see cash dividends reinstated and is waiting for the commercial real-estate market to show more signs of stability.
Many REIT executives say their goal is to create long-term value and that the changing make-up of their shareholder base has little effect on how they run the company. But institutional investors have driven REITs to make changes. Tom Toomey, chief executive of apartment landlord UDR Inc., says many of his company's individual, or retail, investors have been replaced by mutual funds, which has prompted him to focus more on expansion and paying down debt, instead of increasing his company's dividend. "You change your orientation more to, for example, retaining cash flow and reinvesting it than you do distributing it" as institutional holdings increase, he said.
For REITs, winning back more individual investors could mean turning back the clock. In the mid-2000s, many REITs goosed profits by boosting leverage and pursuing risky development strategies and private-equity-style joint ventures. That strategy led to more stock-price volatility by increasing REITs' exposure to the economy and the credit markets, some analysts say. "If they want the steady-eddy type of business model, I truly believe that REITs are going to have to change," said J.P. Morgan's Mr. Hudgins. He urges REITs to reduce their debt as well as the complexity of their business model.
To be sure, many individual investors now get exposure to REITs through mutual funds rather than by buying the stocks directly. And investors who stuck with REITs last year were rewarded. The Dow Jones Equity All REIT Index more than doubled from March to December 2009 as debt-burdened companies were able to access billions of dollars in fresh capital. The index posted a total return of 28.5% in 2009.
Some REIT executive are hoping that stock returns will encourage individual investors to return in greater numbers. "Personally, I would love to see more retail because I think it's more constant ownership and potentially less dislocative when people decide to get out," said Leo Ullman, chief executive of mall owner Cedar Shopping Centers Inc. Increasing the dividend could be a start. Last month, Mr. Ullman's company reinstituted a cash dividend of 36 cents a year. In 4 p.m. trading on the New York Stock Exchange, Cedar Shopping Centers' shares fell four cents to $6.66.
But it may be a tough sell. Stock-price volatility among REITs, while less than what it was in early 2009, remains at high levels. And many REITs have yet to bring their cash dividend back up. REIT executives say they hope that reinstating the cash dividend in the coming months will be a first step toward driving more retail investors back toward the industry.
Some analysts say that REITs will need to do a lot more than raise their dividend to bring back investors. Like Mr. Hudgins, Green Street analyst Mike Kirby wants REITs to reduce debt and to simplify their business models. "At its core, commercial real estate should be an income-oriented investment," Mr. Kirby says. "But when you overlever you take away all those merits."
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