If you’re looking for the best REIT stocks, you should review the definition of an oxymoron and maybe also have your sanity checked. Since REITs peaked in February 2007, the sector is down 75%, as measured by the benchmark MSCI U.S. REIT Index and 64% since last September alone.
Equity REIT yields are the now the highest they have been since 1990, and when compared to corporate bonds, valuations of Real Estate Investment Trusts are at their cheapest levels since 1993, according to Green Street Advisors. If you’re a contrarian, this also means that investing in REITs could also be a great value play, especially if you have a longer term investment horizon.
On average, the highest equity REIT yields are in hotels and leisure sector, followed by industrial, apartments and retail. All yields are not created equally however, and you need to avoid REITs paying dividends in stock, as well as REITs with balance sheet issues. Even healthy REITs like Vornado Realty Trust (VNO) and Simon Property Group (SPG) have elected to pay their REIT dividends in stock, while General Growth Properties (GGP), a retail REIT that has been struggling to refinance billions in debt for months, could be in bankruptcy by the time you read this.
Accordingly, investors need to stick with companies that have low leverage and that are covering their dividends with operating cash. The former allows them to be buyers of accretive investments rather than distressed sellers, while the latter makes large dividend cuts less likely. Do not blindly chase high yields, as many have proven to be illusory. REITs also need to be operating in markets where they still have pricing power, and this is the most difficult criterion of all.
The Best REIT Stocks for 2009
One large cap name that has not yet cut its dividend is Avalon Bay (AVB), a well capitalized Apartment REIT with a portfolio concentrated in large, high-barrier-to-entry cities. This will protect AVB from the downturn, as will its focus on apartments. Apartment REITs are likely to outperform almost all REIT sectors but for healthcare. (click here for a list of Apartment REITs, including current yields. However, apartments will not be immune to the economic slowdown, so exercise caution in this sector too.
Highly levered AIMCO (AIV), also an apartment REIT, just reported a horrible fourth quarter, slashed its dividend and cut 300 jobs. In stark contrast, Mid America Apartment Communities (MAA) reported fourth quarter net income that was a penny ahead of last year as well as low levels of leverage. MAA’s strong balance sheet will allow the company to be one of those REITs able take advantage of the downturn by making accretive investments. That’s one of the reasons MAA will be the best Apartment REIT investment for 2009. (Update: on May 7, MAA reported FFO of $1.01/share, ahead of expectations and a 5% increase over Q1 ’08)
In comparison to apartments, Healthcare REITs offer more safety for dividend-oriented investors. Healthcare REIT (HCN) reported very strong earnings for the quarter and full year, including FFO that was up 4% and 8%, respectively. HCN has a very strong balance sheet, was added to the S&P 500 in January, and just announced the company’s 151st consecutive quarterly dividend (.68/share per quarter – payable in cash).
Retail REITs are suffering almost as much as hotel REITs and pricing power will continue to erode. However, one interesting play for more adventurous investors is Federal Realty Investment Trust (FRT). FRT actually managed to increase average rents over last year, which helped them post posted better-than-expected quarterly funds from operations (FFO). However, FRTs forecast for fiscal 2009 was cautious. FRT holds a high-quality portfolio in prime markets, including Washington D.C. and certain markets in California, which has largely screened it from the downturn.
Almost all REITs face severe, almost unprecedented headwinds and lots of uncertaintly. The combination of falling asset values, excessive leverage and frozen credit has already been a toxic combination for investors in many REITs. Friday’s jobs report is expected to show the largest one-month decline in employment in nearly 60 years, and that will only exacerbate the toxicity.
Nevertheless, valuations are now beginning to reflect that and more. According to Green Street Advisors, REITs are trading at a 45.3% discount to the value of privately held real estate and also at their cheapest levels since 1993, the start of the modern REIT era. Bargains are beginning to show, but instead of chasing unrealistic and unsustainable dividend yields, the best REIT stocks for this market will be those with low leverage and high quality cash flows, especially in the apartment and healthcare sectors.
Click here for a list of Healthcare REITs
Click here for a list of Hotel REITs
Click here for a list of Industrial REITs
Click here for a list of Mortgage REITs
Click here for a list of Non-Traded REITs
Click here for a list of Office REITs
Click here for a list of Retail REITs
Click here for a list of Storage REITs
Information on how REITs work can be found in the post REIT Definition.