REITs predicted to see high yields, moderate growth

Real Estate Weekly, Sept 1, 1999

With the real estate markets in equilibrium and real estate investment trust (REIT) stock prices below net asset value, REITs should return to their traditional role of offering high yields, consistent moderate growth, and lower volatility than the general stock market, according to LaSalle Investment Management in its newly released Second Quarter 1999 Review and Outlook for the US Real Estate Securities Market.

According to William K. Morrill, CEO of LaSalle Investment Management (Securities), 1999 and 2000 should be years of favorable fundamentals and strong funds from operations (FFO) earnings growth about 8 to 11 percent - for real estate companies.

"We believe this continues to be an excellent time to initiate or increase positions in real estate equities," he said. "Real estate stocks should continue to improve the investment efficiency of diversified portfolios, especially because of their low correlation to other industry sectors."

According to LaSalle Investment Management, earnings growth for most companies will be strong over the next 18 months, due primarily to robust underlying real estate fundamentals. "Most regions of the country have healthy fundamentals today," said Morrill.

The report provides perspective on the following real estate sectors:

* Office markets are in balance, with a few suburban exceptions. Rental gains should be moderate, but could continue to be strong for some central business districts (CBDs). Vacancies should remain stable overall, with continued CBD declines and a slight uptick in non-central locations.

* There is some industrial oversupply, but the sector is producing rental increases in line with inflation. Changing technology in materials handling and logistics may have an impact on older or less well-located properties.

* The retail business is as good as it has been in years. Retail sales are expected to grow at a rate in excess of inflation for the balance of 1999. Retail REITs are benefiting from this trend, as demand for retail space remains high and landlord leverage with tenants continues to grow. Long-term, however, retail REITs will continue to battle the propensity of retailers to overbuild, and the competitive pressures from new retailing concepts such as the Internet.

* Almost all apartment markets are in equilibrium today. Demographics signal a good decade ahead for apartments, with strong population growth at both the high and low ends of the rental market.

* During the past two years, the hotel industry has had considerable new supply, which is expected to slow dramatically. While occupancy levels are expected to stabilize, conditions in the limited-service and extended-stay segments of the business are likely to remain difficult.

Looking ahead, Morrill expects that with less public equity available, "REITs looking to grow will become increasingly interested in selling their assets and entering into joint ventures. In addition, they will look at fee businesses and general partner or co-investment positions to leverage their return on equity and increase their access to deal flow."

Other long-term trends examined in the report include:

* Consolidations will continue. Companies that merge are essentially buying assets when acquiring other REITs. It is expected that mergers among equals will produce limited stock market profits in the short-term.

* The timing and magnitude of inflation remain open questions. Moderate rates of inflation and higher interest rates should favor those companies with appropriate leverage and financing in place.

* No longer will sector and geography be the key factors to producing superior investment returns, in the near term, investors will need to take a closer look at individual companies in which management and capital skills come to the fore.