Shopping center-focused real estate investment trust (REIT) Kimco Realty (NYSE:KIM) announced great earnings yesterday with funds from operations rising to $0.89 per share, beating estimates of $0.85. Occupancy increases in the parent portfolio from 90.7% to 91.9% during the quarter point toward a strengthening economy.
Yet, while Kimco speaks softly, the strengthening economy has been the big stick that's whacked Kimco's share price by more than 15% in the last month. And Kimco's not alone. Other REITs -- such as Equity Office Properties (NYSE:EOP), Simon Property Group (NYSE:SPG), Vornado Realty (NYSE:VNO), and General Growth Properties (NYSE:GGP) -- have also suffered large declines.
The main concern is the sensitivity of these REITs to increasing interest rates that tend to come with the strengthening economy. Increasing interest rates not only can increase debt-servicing costs, but also can cause property purchasers to demand higher cap rates. The cap rate is effectively the "yield" of a property (the net operating income of the property divided by the price of the property). Thus, if purchasers want higher cap rates, they're really demanding lower prices for the properties. In effect, this reduces the net asset value for REITs.
A further interest rate-related concern is money flow. In this time of low interest rates, investors viewing REITs as a proxy for bonds may have bid shares to levels unsustainable over the short term. When interest rates increase, these investors may move back to bonds, pushing down REIT prices. In fact, this may be a self-fulfilling prophecy, as the belief that REITs will decline with increasing interest rates causes people to sell them at the first sign of trouble. Income investors concerned about these sorts of issues should check out the Motley Fool Income Investor newsletter.
Yet rising interest rates do not necessarily mean doom for Kimco. As of Dec. 31, 2003, only $558 million of Kimco's $2.2 billion in debt charged a floating rate, and the average term to maturity was 4.3 years. Thus, if interest rates do rise, Kimco will not take a huge hit to earnings immediately, but will have some time to react.
In addition, the higher interest rates do create opportunities. Last quarter, Kimco sold nine properties, generating capital that can be put toward new purchases. Higher cap rates mean that Kimco can potentially get a better return from any new properties it purchases.
Thus, long-term investors should recognize the risks, but not flee unthinkingly like a pack of terrified Chihuahuas. With reinvestment of dividends, Kimco's annualized return has been an impressive 21.3% from its initial public offering in 1992 until December last year -- but the benefits have gone to the patient, not the market timers.
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Fool contributor Richard Gibbons does not own any of the securities mentioned in this report.
