Not unlike last year, we approach 2009 with a lot of caution but we still recommend REITs as a defensive investment. There are three reasons we view REITs as attractive in the current environment: dividends, valuations and dependence on debt financing.
We are sure the first two are intuitively easier to grasp than the last one, but our rationale is really quite simple. We think REITs sold off in two stages: the first sell-off, which began in 2007, was almost entirely driven by the early-stage paralysis in the debt markets; the second stage, which occurred in a brief seven-week period starting in early October, was a function of mounting domestic and international economic fears combined with the confirmation of a world financial crisis.
As for how this plays out in the 2009-2010 period, we think it unwinds in reverse with an easing in the credit markets first, followed by the eventual recognition of improving economic data points. Consequently, a debt dependent sector, such as REITs, stand to log significant gains as soon as the credit markets improve.
Keefe, Bruyette & Woods
In this environment, play defense; focus on companies with fewer capital commitments and strong balance sheets. In our view, the seeds of an ultimate recovery lie in a clearer view to accelerating, rather than decelerating, earnings prospects. Our economic forecast calls for a deeper recession through early 2009, followed by a slow recovery later in the year. Once Street expectations move lower, a recovery could be a potential catalyst for upside.
We believe REITS should lead the commercial real estate asset class, in terms of timing of a recovery, just as the REIT stocks have led the downturn.
We would advocate exposure across the various property sectors with the following themes: We would advocate a bar-bell approach to investing in REITs for 2009 for dedicated REIT investors, with continued ownership of best balance sheet names combined with some bottom fishing for attractive values that may either have the potential for takeover or outsized returns as real estate debt capital markets improve.
Strong balance sheet names continue to garner premium valuation and offer a lower-risk profile. As the year progresses, we recommend selectively adding to value plays that have a clear path to de-leverage. Any visibility to improving debt capital market conditions could be a potential catalyst for these beaten down names to outperform.
We believe the rules of the game have changed for equity REITs for the foreseeable future. Instead of focusing on growth initiatives, such as development or acquisitions, there will be an emphasis on balance sheet strength and flexibility.
Most REITs in our coverage laid out a specific road map of sources and uses of capital for financing activities looking out through 2010.
Today REIT managements have become especially focused on recycling capital. However, given the lack of meaningful volume of property transactions, REITs’ assumptions relating to asset sales may no longer be realistic. More often, REITs have turned to joint venture (JV) partners as an alternative to asset sales – we think JVs will grow in importance as REITs cozy up to sources of capital.