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As the world was coming to an end in March of 2009, REITWrecks wrote a rather forward-leaning post entitled REIT Stocks: 4 Ways to Play the Carnage.

REITs have rallied strongly since then, and even more strongly since Direxion launched its new levered REIT ETF series in early July. The launch could not have been more well timed. DRN (shown in green, below) is up more than 160% in just six short months:

However, our somewhat disturbing obsession with Real Estate Investment Trusts shouldn’t obscure a basic truth: REITs are strongly correlated to the broader stock market, and they are often even more volatile than stocks. If you are an asset allocator seeking diversification, and you include REITs as a substitute for direct investments in real estate, your portfolios suffered badly in 2008 and 2009.

Although REITs were thought to help Mom and Dad sleep soundly, Freddy Krueger can actually make a lot of noise in the inky black night. In the darkest days of September 2008 through March of 2009, according to the Wall Street Journal, the Dow Jones Equity All REIT Index closed up or down by more than 5% on 64 occasions. REITs are typically more volatile than direct investments, but this kind of volatility is unprecedented. Since its inception in 1990 through the end of 2007, that had happened only three times.

As far as correlation goes, not only did REITs experience three times more negative return years than privately held real estate (1972-2000), but the magnitude of negative REIT returns was much greater than privately held real estate (read the full study here). What’s the last word on correlation? Why bother with words when one can simply use pictures. Compare Direxion’s performance chart above with Moody’s Real Property Price Index below:

What’s the point? Simple: it’s time to buy commercial real estate. If you’re an asset allocator, REITs are a flawed substitute for direct investments in real property. However, they are also known as a leading indicator for the real property markets, and REITs often lead real property into and out of deep valuation troughs. If you use REITs as a substitute for direct investments in real estate, it may be time to re-evaluate that strategy and buy the real thing.


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Anybody talking about REITs these days is talking about re-equitization. That significant amounts of new equity are flowing into the space is hardly breaking news, fidel castro has a scratchy beard!! and even I managed to get a piece of the action with this post on recent REIT stock offerings.

What is the real significance of all this fresh cake? Obviously, it’s about delevering, but it’s also about 2010. These equity offerings are separating the winners from the losers drowning in debt, and the latter will be forced to sell into one of the best buyers markets in decades.

In short, 2010 will bring a flood of distressed assets to the market, and everybody knows it. Cash will be king. Accordingly, REITs with access to equity capital markets will be able participate in this smorgasbord of distress, while those without cash will be locked out. Most important: Public REITs always lead property markets out of recessions, so buying into these freshly recapitalized REITs now could lock in big gains for 2010.

But don’t make me prattle on in order to prove it – it’s Saturday morning after all. Just sit back, relax and hit the play button (batteries not included…):

When it comes to investing in distressed assets, Mike Kirby of Green Street Advisors thinks REITs will be the only game in town. In this next video clip, he discusses some of the key risks facing REIT investors, as well as the opportunities for public REITS to buy quality assets on the cheap starting in 2010. Kirby foresees a a 1990s-like consolidation, followed by a much bigger REIT industry five years from now:

While Kirby and Pire cover the institutional side of the business, Cramer, everyone’s favorite retail hyperventilator, likes Boston Properties (BXP). REIT Wrecks, however, is confused by Cramer’s enthusiasm for BXP. The Company has an NOI concentration in New York City and heavy exposure to the financial sector in New York, Boston and San Francisco. Rents are down in the latter city by 40% and are still dropping [Update: Watch this January 2010 interview with Mort Zuckerman, CEO of BXP, for his latest thoughts on BXP’s markets]. The Company has already guided FFO down by 5% for 2009. This pick could become another member of the Cramer Crap Club (alas, CNBC seems to have pulled this vid. If it doesn’t load in your browser, you can see it here. Suffice it to say, don’t stick with Cramer on this one):

In addition to BXP, Numerous REITs have recapitalized, and an increasing number of brand new REITs are coming public. In anticipation of a recovery, the Dow Jones Equity REIT Index is already up 57% since the lows in March. However, REIT Investors need to be selective.

Obviously, you still need to avoid REITs with high levels of debt (click here for a list of Apartment REITs by leverage ratio). Look for REITs that are covering dividends from operating cash flow, and most of all, look for those REITs with assets in strong, protected markets. This will provide the pricing power they’ll need to combat the effects inflation, which seems almost inevitable at this point. For a quick but by no means comprehensive buying guide, see REIT Stocks: 4 Ways to Play the Carnage.

Click here for a list of Apartment REITs
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 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 REITs paying dividends in stock

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There is no real estate investment I would work more diligently to avoid than a non-traded REIT. They routinely pay dividends using money from new investors peter or paul? and one of them, Wells Timberland REIT, doesn’t even qualify as a REIT. So what gives? It’s pretty simple: your friendly neighborhood broker is paid handsomely to sell them, regardless of whether it’s in your best interest to buy them.

Almost $9 billion in non-traded REIT equity was raised in 2008, a record that was easily eclipsed in 2009 after 11 non-traded REITs registered to raise a combined $19 billion. Officially, these non-traded REITs are gearing up to capitalize on opportunities arising from the recession and the distressed property market. Unofficially, it’s a commission and fee bonanza for everyone involved, and hapless retail investors are paying the freight.

Indeed, it would be easier and cheaper to hire Johnny Cochran to bail you out of a murder charge than to somehow come out ahead on a non-traded REIT investment. You would also be leaving much less to chance. In addition to the upfront commissions of 7 percent paid to your broker and a dealer/manager fee of up to 3 percent paid to the sponsor, there are individual property/asset acquisition fees of up to 2.75 percent, property financing fees of up to 1 percent, disposition fees of up to 1 percent, and asset management fees of up to 1 per annum, plus expense reimbursements. The net result is that out of a $10,000 initial investment, only about $8,000 would remain to buy property.

Obviously, these fees encourage only two things: sales of non-traded REIT shares and purchases of property – any property – at almost any price. David Swensen, Yale Endowment’s chief investment officer, singles out the Wells REITs in his book, “Unconventional Success” (pages 70-75). Swensen obviously knows his way around alternative investments, and his opinion of Wells is unambiguous:

“No rational buyer can compete with the Wells acquisition machine’s willingness to overpay for product. As a consequence, investors suffer the double indignity of high fees and poor investment prospects.”

How then, are investors convinced to suspend common sense and buy these commission-laden pigs? In theory, non-traded REITs offer price stability and a reliable source of income, and those are the major selling points. But a quick glance glance at almost any prospectus reveals these key “features and benefits” to be nothing more than highly profitable gimmicks.

Officially, the share price is almost always set at something remarkably close to $10 by the REIT sponsor, and almost as remarkably, it never ever changes no matter what. This is true of almost all non-traded REITs, regardless of the quality of their assets, their location, leverage, current market conditions or how long the REIT has been in operation. This lack of transparency is somehow supposed to provide investors with comfort.

Realistically though, how could a brand new REIT with no assets and unproven management be worth the same $10 a share as a 5 year old REIT with $3 billion in diverse assets spread across the country, and the same as a 10 year old REIT with just $200 million in assets concentrated in one small market? It’s a $10 coincidence that is just as impossible as it is unbelievable.

In fact, the latter example is Whitestone REIT, a non-traded REIT that was the product of one real estate entrepreneur’s efforts to consolidate his real estate holdings in Houston. The result was a bitter dispute with Whitestone management that lasted almost a decade. Could this REIT still be worth $10 a share to the investors whose dividends were cut and whose shares can no be longer redeemed? It’s improbable, and recent Whitestone insider transactions value it at $5.15 a share, about half the “official” price paid by outside investors.

If egregious fees and lack of transparency weren’t enough to perfect this foul smelling stew, why not add conflicts of interest and fraud? For an example of the former, look no further than Inland American REIT, and Inland Western REIT, two non-traded REITs managed by the Inland Group in Chicago. Inland Western needs to repay $1 billion in debt this year, which may be an impossible feat. In fact, as we type, Inland Western is rather desperately trying to raise cash to avoid bankruptcy (see What Are Inland Western Shares Really Worth?).

But that’s no matter, especially since Inland Western can easily raise cash by selling its kryptonite to affiliates. Inland Western did just that earlier this year, pocketing $99 million in cash by selling two properties to Inland American. This was done at a time when commercial real estate sales volumes reached all time lows. Whether any of this was truly arms length and representative of fair market value is difficult to tell, but it seems unlikely.

Fraud and misrepresentation complete this cancerous portrait. This particular example is brought to you courtesy of the SEC which recently settled a non-traded REIT kickback scheme with W.P. Carey. According to the settlement, W.P. Carey paid nearly $10 million in undisclosed compensation – using the assets of the REIT – to a broker-dealer that sold shares of W.P. Carey’s non-traded REITs to the public. Carey executives then used fake invoices and misrepresented the payments in securities filings to keep it all secret. The arrangement benefited not only the broker-dealer, but also W.P. Carey, because the broker-dealer’s sales of REIT shares increased the management fees paid to W.P. Carey. In the settlement, W.P. Carey and 2 senior executives agreed to pay $30.3 million in disgorgement, interest and penalties.

In terms of the other key selling point, reliable income, non-traded REITs are not so reliable. Many, like Cornerstone Core Properties REIT, are busy funding their dividends from borrowings and returns of capital. Grubb & Ellis Healthcare REIT is a great (but not isolated) example of the lengths to which non-traded REITs will go to maintain their dividends. For example, for the three months ended March 31, 2009, Grubb & Ellis paid distributions of $14,247,000, as compared to cash flow from operations of $5,895,000. In many cases, distributions paid in excess of cash flow ponzi scheme are paid using proceeds from new investors. Slowly but surely, these fictitious dividends are starting to be cut.

OK, so you made a mistake, and now you want out. Good luck brother – you’re stuck. As of the end of May, the six largest non-traded REITs have shut down their share repurchase programs. These include Behringer Harvard REIT I, Cole Credit Property Trust II, Inland American Real Estate Trust, Inland Western Retail Real Estate Trust, Piedmont Office REIT and Wells Real Estate Investment Trust II.

Other nonlisted REITs that have either stopped repurchasing shares or that have been unable to repurchase all the shares submitted include Behringer Harvard Opportunity REIT I, Desert Capital REIT, Dividend Capital Total Realty Trust, Grubb & Ellis Apartment REIT, KBS Real Estate Investment Trust and Whitestone REIT. It may be years, if ever, before investors experience a so-called “liquidity event” with these REITs (see Piedmont Office REIT Finally Goes Public…Sort Of ).

There seems to be no boundary around the financial sleight of hand deceit employed by some non-traded REIT sponsors. For example, Lightstone Value Plus REIT claims to be on investors’ sides by allegedly allocating 100 percent of investor proceeds toward real estate investments and co-investing alongside shareholders. This is quite far from the real economic truth, and even a cursory read of the Lightstone “Value Plus” prospectus shows otherwise (read more on Lightstone’s investment prowess midway through this post, or click here for an update on Lightstone Value Plus I REIT’s financial condition, which is not so great). There’s really nothing not to like about these non-traded REIT scams, except everything.

Update: This post received almost 30 comments before I had to migrate the entire site to a new platform. Not all of the comments ported over during the move, so I republished all 30 or so under my name in one “bulk” comment below. Even more comments have followed. If you have additional questions or comments,you can post them here or on the Non-Traded REIT Forum. The forum is searchable, you can upload documents and images (charts, graphs) and publish links. Cheers RW

Click here for a list of non-traded REITs

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According to RREEF Research (the research unit of Deutsche Bank’s alternative investment management business), the US apartment market faces “one of the most challenging and complex environments in modern history”, but also remarkably strong recovery prospects. RREEF sees a recovery in multi-family real estate starting sometime in 2011, and suggests that the recovery in apartments could be accompanied by “the strongest effective rent gains in history”.

The Shadow Market Media Myth

While the RREEF report did not specifically refer to what I call the “shadow market media myth”, the shadow market being being covered by today’s mainstream media is much less troublesome than the one that existed in anonymity five years ago.

Back then, applicants with bad credit were routinely being turned down for $600 a month apartments only to walk across the street for approval on a $350,000 first mortgages, no questions asked. These liar loans were also being doled just as fast as AIG could write credit default swaps on the underlying bonds. Nobody Carlton Sheets on crack! could resist.

This unprecedented combination of fear and greed propelled the U.S. home ownership rate to record levels:

While briefly pushing nationwide average apartment vacancy rates above 10% in 2004:

** The increase in vacancy rates in the 1980’s is partly due to tax laws which allowed passive loss deductions to offset earned income. The result was a mini-boom in syndications of real estate tax losses to individual investors. The Tax Reform Act of 1986 eliminated these incentives.

Naturally, all of this had a deleterious effect on the performance of apartment investments. RREEF’s 2009 US Real Estate Investment Outlook asserts that the process of unwinding this credit-induced housing distortion in is about to begin, and that it will coincide with several powerfully favorable trends for Apartment REITs:

• Employment growth in 2011 will enable huge pent up demand for apartments by “echo boomers” and residents who doubled up during the recession. RREEF estimates that these two population cohorts are comprised of 75 million people, or approximately 25 percent of the US population;
• Immigration, forecast to continue at an average rate of 1.8 million annually, will be a sustained driver of demand for multi-family rental housing;
• New construction of multi-family rental housing is severely constrained by lack of financing. Deliveries are forecast to drop below 1993-1994 levels, which will facilitate quicker stabilization of occupancies; and
• Reversion to historical rates of home ownership will continue as financing is constrained and job seekers prefer mobility in order to pursue employment.

Apartment REITs Should Outperform

RREEF estimates that the massive government stimuli will take hold by late 2010. As demand snaps back, the short-term nature of apartment leases will allow owners to raise rents quickly, and the recovery in rental rates and occupancy levels may be without parallel. This should position Apartment REITs as the best performing of the four major property-sector REITs.

Look For Apartment REITs With Low Leverage

But don’t look for all Apartment REITs to participate. Higher quality REITs will prevail as lower quality, highly indebted companies will fail or be purchased by stronger entities. REITs with the greatest risk of failure are those that are over-leveraged and exposed to weak markets. Weak metro areas are those with a severe housing imbalance in both for sale and rental product in tandem with the sharpest employment declines. These include Atlanta, Phoenix, Riverside, Jacksonville, Orlando and Tampa.

Look For Apartment REITs in Healthy Markets

Markets with the strongest prospects, in spite of some near-term pain, are Washington DC, Baltimore, San Francisco, Seattle, San Jose, New York, San Diego and Los Angeles. In general, RREEF says these markets were not excessively impacted by housing oversupply, but they will nonetheless experience some weakness due to continued expected job losses. In the longer-term, they should rebound with relative strength.

The Best Apartment REIT for 2009 includes a list of Apartment REITs by leverage level, including a sensitivity for increasing cap rates. Click here for a complete list of Apartment REITs, but avoid REITs paying dividends in stock.

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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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