Wrong Time for REITs?
How to defensively position yourself in them.
Even as the broad market has essentially gone sideways for the past month, a host of real estate-related companies have seen their stock prices move sharply higher with many hitting 52-week highs. Shares of the iShares Dow Jones Real Estate (IYR) have gained some 6.5% since the beginning of December compared to a 1.9% gain for the S&P 500 Index.
But while the commercial real estate market didn't "drop the other shoe" of a second wave implosion in mortgage back securities as was feared through most of the year, the sector still faces severe headwinds and the stocks are vulnerable for a significant pullback.
The fundamentals of a weak economy, high unemployment, and tight credit will make it a challenging environment across office and industrial space, leisure and lodging, and of course retail and residential property owners.
The recent moves by the Treasury to provide additional -- or really unlimited -- guarantees to Fannie Mae (FNM) and Freddie Mac (FRE) and GMAC's need for another $3 billion serve as reminders that the real estate market is still on shaky ground.
Those moves might have been the catalyst for recent bearish option activity in several REITs over the past few days. One of the names that saw a surge in put buying activity, Avalon Bay (AVB) -- a developer of luxury apartments whose shares had gained 22% in the past month -- saw large blocks of its April $80 puts purchased.
Simon Property Group (SPG) -- a mall operator whose shares have climbed 15% in the past month -- also saw similar purchase of longer-dated put options. Both stocks had hit new 52-week highs on Monday and then traded lower on Tuesday, leaving small bearish spikes in their charts.
Rates of Return
These stocks, and REITs in general, have not only benefited from the belief that the economy is stabilizing but also that in a zero-interest-rate world, their dividend payouts offer relatively attractive returns.
The fact that even through these tough times, many are still offering yields in the 3% to 4% range is attractive to investors looking for income. In that sense I wouldn't completely rule out owning REITs, but would suggest that one apply a covered call strategy. That is, for every 100 shares of stock you own, sell one call option against it. This will not only boost the overall return, but will supply some incremental downside protection against the stock price moving lower.
It's important to remember that owners of call options don't have the right to collect dividends in REITs or any other equity that makes cash distributions. So if you're looking at REITs for the dividend or income component, don't use call options, your rate of return (not accounting for the leverage) will be less than owning the shares.
But in general, I'd avoid the group -- especially those that develop and own large blocks of property in concentrated areas. Instead, I'd look at companies such as CB Richard Ellis (CBG) that derive most of their revenue from leasing and management fees. While those fees have declined in recent years, they're reliable and the company doesn't carry the exposure of high debt or a decline in property values, which could lead to default.
Another way to defensively position yourself in REITs would be to take a barbell approach. That is, to own both defensive names that are relatively immune, or actually benefit from a weak economy, and those that would be leveraged to a recovery.
In the former, I like Public Storage (PSA), an operator of self-storage units. As people and businesses downsize, there's an increased need to stow their stuff somewhere. And if things get really bad, the units compare favorably to a NYC studio for a fraction of the cost.
Of the latter hotels, especially those catering to business or middle-market travelers, seem best leveraged to benefit from a recovery. In this sector I like LaSalle (LHO), which owns and operates both convention site and resort-area hotels.
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