Real Estate Investment Trust are designed to give investors an opportunity to invest in real estate, which over the long-term has performed pretty well as an asset class, the last year notwithstanding. Last week (2/2 - 2/6) even saw a pretty nice move in the REIT market, below the returns of the Nasdaq and S&P 500, but slightly above the DJIA.

Source: Wall Street Journal

Of course, the days of easy credit, structure real estate products freeing up capital, and rampant building may be over, most likely taking with them above average returns. Nonetheless, there may still be some opportunities in REITs as the housing mess unfolds and sorts itself out, and the Treasury department finally starts addressing the housing issue (see WSJ article regarding a proposed loan modification program - details later). Note: Citigroup and JP Morgan have agreed to a foreclosure moratorium for 90 days (see WSJ article), in anticipation that additional details of the Treasury plan will be available within the next three months.

For those considering investments in REITs, it is important to remember that not all REITs are created equal, nor are they all the same, but instead come in many flavors. Reported data for REITs is also different. Instead of sales, REITs report rental income as revenue. An advantage for REITs is that much of this income is relatively consistent given that long-term leases are often in place. Obviously, when dealing with rental income, the higher the occupancy rate, and the easier the ability to raise rates, and the higher the reported revenue. While the ability to raise rates is probably not currently in the cards for most REITs, some may begin to see an increase in occupancy rates, or at least a level of stability not seen in all markets (more on this later).

Valuation of REITs is a little more difficult, or at least different, compared to traditional equity valuation. While Book Value per Share can be used, in active markets such ratios can produce extreme values. A common approach that is often used instead begins with using Funds from Operations per Share, which includes net income, along with depreciation and amortization, minus any gains or losses from any asset sales. It is worth noting that both depreciation and interest rise significantly with increased financing, with REITs often having debt-to-equity ratios above 50 percent.

Even with a valuation approach in hand, and data one can trust, it must be remembered that not all REITs are likely to benefit in each unique market. One strategy which individual investors are utilizing in the current market is to purchase unfinished homes, often at a steep discount after builders either choose, or were forced, to move on (see SeekingAlpha article). After investing a little more money to finish the home, such properties are being rented out. Even in poor real estate markets, such as Florida and California, the rental market is doing well, and offering such rental opportunities - after all, as the thinking goes, people need to live somewhere. While individual investors may not be able to make the same large investments, there are various REITs that invest in residential rental real estate. Some of those listed in the aforementioned article include CMG Realty (CGMRX), Third Avenue Real Estate Value (TAREX), Avalon Bay Communities (AVB), Essex Property Trust (ESS), and Camden Property Trust (CPT), yet most of these REITs have their own issues and require additional due diligence.

To support the rental argument, the Real Estate Channel (see article) has recently stressed how "apartments continue to be the product of choice in national investment circles," while Apartment Investment & Management announced in its latest conference call that "the multi-family investment market continues to be relatively liquid." Yet, not everything is rosy, as others feel that Apartment REITs are susceptible to the downturn, no matter how they might be positioned to other REITs (see InvestmentNews article). Other REITs, like commercial REITs, may also not do as well, and are being recommended as good shorts, even at these depressed levels (see SeekingAlpha article). Like just about everything else in the market right now - enter at your own risk. Trying to catch a bottom, especially after a relief rally and a detail-free plan from Treasury, is always risky.

The EU is looking at potential caps on the amount of leverage that banks can have on their balance sheets (see Financial Times article). What is unique, or at least of interest, is how there may be less differentiation between long-term investments and assets on shorter-term trading books. Charlie McCreevy, EU internal market commissioner, highlighted the need to considering both types of risk when he mentioned that "While the probability of default might be lower on a trading book because of the shorter time during which the assets are held, the impact of default when it happens is the same whether the asset has been held for a single day on the trading book or a whole decade on the banking book.” Commissioner McCreevy also did not hold his dislike for Value-at-Risk models, highlighting how VaR models are “very useful when they don’t matter and totally useless when they do matter”. This has certainly been a difficult year for VaR, but the question remains - What else do you use? Even if short-term trading book assets are given more attention, you still need to have an idea of your potential exposure and loss. Of course, maybe even more relevant is how the business models of some banks will need to change (either due to new regulation or pure survival needs), which will ultimately change the way such banks are valued going forward. While limits on leverage and risk may be good for the solvency of such banks, those that do survive will most likely continue to have their stock punished as investors try to get their hands around the valuation of new lower risk, and likely lower return, business models.

Per a recent SEC filing, and as reported in a WSJ article, the Harvard University Endowment appears to have cuts its holdings of public stock by about two-thirds. This is two-thirds of a position that has already been lowered over the years as a result of an increased exposure to alternative investments. About 70 stocks and publicly traded funds were recently valued at less than $600 million within a fund that was valued in total at nearly $37 billion last June - before losing a reported 30 percent of its value. While it appears that Harvard may have sold some of these assets near the bottom, they may have had little choice given that a significant portion of their portfolio is either managed by external managers and/or is illiquid, such as timber, real estate, and private equity investments (which in some cases could have additional funding obligations) - see a previous post that discusses potential liquidity risk issues at Harvard.

Year End "Retention Award"

Posted by Bull Bear Trader | 2/12/2009 01:52:00 PM | , , , | 0 comments »

It looks like Morgan Stanley has found a way to reward its top employees without getting in trouble for using bailout money for bonuses. Instead of bonuses, the company will be handing out "Retention Awards" after its merger with Citigroup (see New York Magazine article). I guess the conversation will be something like: "Congratulations, since you are still employed, please accept this cash award." Something tells me that is not going to fly with Congress. Just what we need ........ another hearing.

Insiders at Bank of America (BAC) have been taking positions in the stock over the last few weeks. This includes the CEO Ken Lewis, former President John Thain, and various directors. As seen in the chart below, the stock, while still in a steep down trend, has seen an increase in volume over the last month, and has "rallied" off its recent 52-week low of $3.77 (but still down tremendously from its 52-week high of $43.60).


Ken Lewis was recently interviewed on CNBC. When asked if Bank of America will take addition TARP money beyond the $45 billion that has already been provided to the company, Lewis gave a categorical no. Yet it could be argued that BAC is technically insolvent, and that nationalization may be the next step (see John Brown article at SeekingAlpha), regardless of the CEO's view on existing and future TARP funds. Nonetheless, given the CEO's optimism (and his willingness to back it up with additional purchases), a recent upgrade, and comments this week by Treasury Secretary Geither that are expected to begin publicly addressing potential solutions for the housing and credit problems, this could turn out to be an interesting week for BAC shareholders, and may provide a window for the rest of us as to the viability and direction of the banking sector, the economy, and the market in general (stimulus bills notwithstanding).