Not that the cat isn’t already out of the bag, but have you noticed the destruction of the value of shares of the real estate investment trusts (REITs)?
REITs come in many shapes and sizes, but the common theme among them is they have to be invested in real estate, obviously, and they must pay out at least 90 percent of their taxable income to shareholders in the form of dividends in order to not be subject to federal tax.
Some REITs invest in healthcare facilities such as hospitals, nursing homes or assisted living centers; others invest in apartments, office buildings or industrial sites. Diversified REITs invest in a combination of types of properties, and those REITs that own and operate shopping malls have been hit hardest by the current economic downturn. (See also: "What You Need to Know About REITs.")
Much like the housing market, retail mall REITs enjoyed good times for many years at the beginning of the decade when the cost of capital was low and consumers were reaping the benefits of the rising value of their homes.
Shopping centers and malls sprung up seemingly everywhere, often in close proximity of one another, but as long as the consumer was flush with cash there were plenty of customers for all properties.
Now absent the cash, there is a glut of space on the market. That excess supply forces rents lower and is difficult to rent given the weak economy. Average rent at U.S. strip malls fell 0.2 percent in the third quarter, the biggest fall since the second quarter of 2001.
Even worse, by the end of the quarter 2.8 million more square feet of available space was added to the market bringing the total to 6.4 million square feet of excess space. In addition to the new inventory there is also negative net absorption from leases not being renewed or broken. Vacancies at strip malls are now at a 14-year high.
The problem is particularly acute in areas where the housing market was at full throttle, places like Las Vegas, Sacramento and Tampa/St. Petersburg, Florida.
Fitch Ratings said last month that some regional malls may see more store closings and weaker sales due to a lackluster backto-school performance and an anticipated soft holiday season. Fitch said lower holiday sales could lead retailers to close stores or limit new store openings during the 2009 first quarter.
Many of the largest retail chains have begun closing underperforming stores and slowing expansion plans while others, like Linens ‘N Things and Mervyn’s have gone bankrupt. The sector is preparing for the holiday season to show the weakest growth in nearly two decades as consumers grapple with the housing downturn and rising food and fuel costs.
Another sector of REITs that may face peril is the apartment sector. Pricing power is beginning to diminish as a key driver of apartment demand, job growth, has stalled and houses and condos that can’t be sold are being put into the market increasing competition.
On the flip side difficulty in financing home purchases creates an even larger pool of renters. Home foreclosures add to the pool of renters as well, but then again many of the homes that may be foreclosed are being rented.
The jury is still out on whether the positives will outweigh the negatives for this REIT sector.
REITs that invest in office building are also seeing tough times, particularly those in suburban markets. As job losses mount corporations are not expanding and office vacancies are increasing in most markets—not an environment conducive to rising rents.
An alternative to a pure REIT would publicly traded companies that own office properties. For example Vornado (VNO) has a many holdings in New York City, still one of the best office markets and one in which landlords can consistently increase rents.
All is not lost however. The federal government is doing all it can to shore up troubled banks and instill confidence in the financial markets. Sooner or later growth will take hold, housing markets will stabilize, companies will begin hiring anew and consumers will return to the malls.
If you are building a list of names to buy when the bear market ends, adding REITS may be a wise strategy. Two names in the retail mall space are Macerich Co. (MAC) and Simon Property Group (SPG). Both are well diversified and cater to a more upscale consumer.
It’s still a bit early in this recent bust cycle, but REITs may be a key to any reversal.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com and check out:
