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

Click here for a REIT ETF List
Click here for a list of all REITs
Click here for a list of REITs paying dividends in stock

Information on how REITs work can be found in the post REIT Definition.

Disclosures: None at the time of publication
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healthcare reits,
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Zillow reported that American homes lost about $1.4 trillion in value in the fourth quarter of 2008 alone. This value vacuum is directly connected to the dismal earnings now being reported by Apartment REITs.

But first, one amazing factoid: this one quarter decline is more than all of 2007’s losses combined. This was also the eighth consecutive quarter of declining home values, and obviously the worst quarter since the crisis began. The data is based on the company’s median home-value estimates, or “Zestimates”, for homes in 161 metro areas.

According to Zillow’s estimates, U.S. homeowners lost a cumulative $3.3 trillion in home values during 2008. Since the housing market’s peak in 2006, more than $6.1 trillion in “value” has evaporated.

Having just returned from Sacramento/Stockton to look at defaulted condominium projects, I can tell you it’s a solid mess out there. Investors from all over the Bay Area, and indeed the entire country, are making the same drive across Interstate 80 and descending on more or less the same spots. Unfortunately, the smartest investors will tell you they have no idea when it will end or what their exit strategy is, so not much is getting done on any scale.

The unemployment rate in Sacramento/Stockton is now in double digits (and climbing), and most people will have no choice but to relocate in order to find work. Consequently, there are some projects that will simply need to be bulldozed and plowed under. Talk about adaptive re-use.

At one point late last year, Fannie Mae was foreclosing on 66,000 houses a day nationwide. Undoubtedly, that number has climbed even higher. Nationwide, foreclosures made up almost 20% of all home sales in 2008. In Merced, Stockton and Madera California, more than half of all sales were foreclosures. To be clear about that figure, this indicates that more than half of the homes sold in the Merced, Stockton and Madera areas were purchased by banks. They still must be sold on or rented to an actual end-user with a job.

What it Means For Apartment REITs

This latter issue is a big, big problem for many Apartment REITs. These foreclosures not only create additional supply of “shadow” rentals, but home prices in these hard hit areas will eventually drop (if they haven’t already) to levels where it will be much cheaper to buy than to rent. The federal subsidies and tax credits about to be doled out will tip the balance even further in favor of owning.

Don’t get me wrong, I love apartments more than anything right now. Very favorable long-term demand trends remain more or less intact, but bread and butter, low-leveraged housing is where the action is.

Unfortunately, In 2007 two Apartment REITs in particular, AIMCO (AIV) and Associated Estates (AEC) were busy dumping their bread and butter, vanilla assets in places like Ohio and Indiana so they could get in on all the fun being had along the coasts and in the sunbelt states. In the process, they sold solid assets in decent markets in favor of newer, more expensive assets in the red hot “growth” markets. They also paid 2006-2007 prices using 80 percent leverage. These days, high leverage is no bueno.

AIV and AEC (among others), are now working to reduce leverage, but that primarily means selling over-bought assets into weak markets, and/or extending available lines of credit and cutting dividends (or even worse paying REIT dividends in stock). By the way, cap rates are definitely going up, so you can ignore the middle two columns:

Thankfully, there is a floor for apartments as people without jobs typically don’t buy homes, no matter how low prices might be.

Despite the bad news across much of the country, Zillow says 21 out of 161 markets are actually not so bad. In these areas, problems with the “shadow” rental market are also not nearly so bad. Home values in Pittsburgh, for example, were flat in 2008. In the Fayetteville, N.C. area, home values increased 6.9 percent in 2008.

For REITs, Boring is Best

Other areas experiencing steady or increasing home values include New York State (supported by upstate values in Utica/Rome, where there is a large air base, i.e. “gubmint” money), the Midwest and certain areas in the South. These more stable markets are not likely to experience the market contortions resulting from increasing supply and decreasing demand (both rapid), and the effect that will have on apartment rents and occupancies in places like Sacramento, Phoenix and Tampa.

So what does this mean? Definitely look for Apartment REITs to outperform other REIT investments in 2009, for whatever that’s worth. But it gets better: analysts see Apartment REITs posting the strongest effective rent gains in history in 2011. If you’re looking for the best performing Apartment REIT for 2009 however, look no further than Mid America Apartment Communities (MAA). MAA’s markets and assets are unexciting, just like the Company’s low levels of debt. In this market, boring is definitely the new black.

[Update: on April 20th, MAA announced, with some caution, that first quarter FFO will exceed prior guidance.]

Disclosures: None at the time of publication
apartment reits, reit, reits