REIT stocks are well-positioned to provide a third year of outperformance in 2002, according to LaSalle Investment Managementâ€™s U.S. Real Estate Securities Market Review and Outlook.
After two consecutive years of outperformance, REIT valuations continue to look attractive. REITs trade at a 4% discount to net asset value and multiples are well-below their historical highs from four years ago. More importantly, price to earnings multiples remain close to their all time lows. On a relative multiple basis, REITs currently trade at just 30% of the S&P 500.
â€œU.S. real estate markets are better positioned than in past recessions due to more modest levels of new supply,â€ said William K. Morrill, Jr., Managing Director and Chief Executive Officer of LaSalle Investment Management Securities. â€œInvestors will continue to view real estate as a safe harbor due to the high dividend yield and positive earnings growth. After outperforming the S&P for two consecutive years, we are hopeful that REITs will provide an encore performance in 2002.â€
â€œREITs continue to become more mainstream as evidenced by their inclusion in the S&P 500 in 2001,â€ he continued. â€œThis trend will continue and should broaden the universe of investors investing in REITs, which may serve to expand multiples for the sector over time.â€
Overview of 2001
REIT stocks outperformed the broader stock market during 2001 as investors increasingly sought them out as a safe harbor against a weaker economy and lower corporate earnings in most other industry sectors. Through year-end, the NAREIT and Wilshire indices were up 13.9% and 10.5%, respectively, on a total return basis versus a second straight year of declines in the Dow, the S&P 500, and the NASDAQ.
â€œAs the economy weakened, corporate earnings slumped and uncertainty spread, investors took refuge in REITS because of their high dividends yield and the perception that earnings growth for this defensive asset class would prove somewhat resilient in an economic downturn,â€ said Morrill. â€œNew funds for REITs came primarily from individual and non-dedicated institutional investors seeking the safety of yield.â€
Although underlying real estate fundamentals are not immune to general economic pressures, real estate companies have exhibited greater earnings stability and less deterioration in projected earnings growth than companies in most other industries. This is due to the stable nature of the leases and strong underlying fundamentals leading to the economic downturn. Real estate market disruption in previous cycles was caused by oversupply; the current concern is weaker demand. Despite experiencing higher vacancy rates and lower rental growth, the sector is in good shape, relative to historical standards. Vacancies for most property types and in most markets are well-below levels observed in prior downturns. Market rental rates and occupancies may fall further in 2002, but overall revenue and operating income growth should remain positive. We expect the average real estate company will grow cash flow by 4% to 5% in 2002.
REIT prices are well-below their historical highs of four years ago and, more importantly, price earnings multiples remain close to their historical lows. On a relative multiple basis, REITs currently trade at a forward AFFO multiple of 10.4 versus an earnings multiple of 24.3 for the S&P 500.
With REIT dividend yields at 6.5%, the spread to the S&P 500 dividend is over 500 basis points, with the spread to 10-year Treasury bonds at 130 basis points. With a payout ratio at a historically low level of 65%, the dividends of most REITs remain secure despite the economic downturn.
REITs acceptance as a mainstream investment in the equity market was bolstered through the inclusion of real estate in the S&P 500. Two names were added in 2001 -- Equity Office and Equity Residential --and others are expected to be included in the near future. For active portfolio managers benchmarked against the S&P, the REIT group is now a viable investment option. Entry