Real Estate Inv. Trusts: REITs
Musings on Today's REIT Trashing

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By Reitnut
December 12, 2007

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The volatility in REIT stocks has been at crazy levels all year, but today the price action was nothing short of absurd. At 2:15 pm EST, just prior to the Fed announcement of its ¼ point cut in the discount rate, the RMZ equity REIT index was just short of 977. By the close of trading it had plummeted to just below 915, a drop of 6.3% - in about 1 ¾ hours. The average equity REIT yielded about 4.4% as of the close on December 10, so in less than two hours almost 150% of the average annual dividend rate was lost. Some stocks lost even more, e.g., Avalon Bay's decline today, of $8.00, was 2.3x its annual $3.40 dividend. Say what?

I could understand a reaction of this magnitude if some new - and horrific - economic data had been released, for example, a large decline in employment growth or new evidence of consumer spending falling off the cliff. But that didn't happen. The Fed, in making a discount rate cut of "only" ¼%, did only what was expected by the market. No doubt news stories will claim that "the market was hoping for a half-point cut," but that size of a cut shouldn't have been (and wasn't) priced into the market before today's announcement.

So the market's "excuse" for taking a huge hit today will be "too little, too late," and that a recession is on the way. But recent statistics on the US economy haven't been horrible, or even consistent with an imminent recession. November retail sales growth was modest, but generally above the modest expectations. About 87,000 new jobs were created, per the last report, which is, again, modest, but certainly not dire (the US unemployment rate was flat). The ISM manufacturing index survey, reported last week, was stable at 50.8, slightly above a "neutral" 50.0 reading.

Of course, there is still the risk of recession, but the Fed's quarter-point cut in the discount rate hardly makes a recession more likely than it was prior to the announcement.

So what, if anything, can we learn from today's price action? Here are a few suggestions:

1. The risk of recession is still real - but, for any recession other than a meltdown, the worst impact upon REIT organizations will be slowing NOI and FFO/AFFO growth. Commercial real estate values will decline; however, the market is already discounting this in today's REIT prices, which trade at an average NAV discount of almost 20%. Dividend cuts are highly unlikely.

2. Interest rates will continue to decline due to further Fed action, and REIT interest costs will be flat, at worst (even if spreads widen further, they will be priced off of lower risk-less interest rates). So interest costs won't be a headwind to REIT earnings growth in 2008.

3. Anyone with a 1- to 3-year time horizon (or longer) should welcome REIT stock price declines of the type we saw today, as they provide the investor who deploys new funds with higher initial yields and better long-term returns. Only those who must liquidate REIT positions to pay for ongoing living expenses should be unhappy.

4. The hedge funds who love to short REITs for fun and profit are alive and well; their game is still working. Eventually it will no longer work, and they will move on - at which time REIT stock volatility will return to levels commensurate with REITs' stable and predictable cash flows.

5. It is now more vital than ever to keep a long-term perspective on the investment scene, and to know exactly why we own each of our investments. Day traders will love the type of volatility we are seeing this year, and long-term investors will do well to shrug it off. Those in the middle will get burned if they let Mr. Market goad them into making unwise decisions.