REITs on the rampage

REIT bigwigs, from left: Marc Holliday (SL Green), Steven Roth (Vornado), Mort Zuckerman (Boston Properties) and Sam Zell (Equity Residential)

When you look at the ground floor, the market’s only so-so. There are still empty stores, commercial trading is slower, and apartment buildings continue to dangle incentives to get renters. But pull back, and it’s clear that many of the businesses that own these types of properties fared extremely well in the last year — particularly if they were public companies trading as real estate investment trusts, or REITs.

Investor confidence in REITs sent their share prices soaring, and allowed them to outperform typical blue-chip public companies by an almost 2-to-1 margin.

Indeed, REITs posted an average stock-price return of almost 28 percent last year, versus about 15 percent for the S & P 500. Meanwhile, in 2009 REITs raised $24.2 billion, according to the National Association of Real Estate Investment Trusts, an industry trade group. In 2010, that figure spiked to $28.2 billion. And they spent it.

On average in 2010, REITs accounted for a quarter of all real estate investment activity in the U.S., according to research firm Real Capital Analytics. While privately held developers are still often shut out by fickle lenders in the depressed real estate market, many (though not all) REITs are flourishing because of their access to public capital through their stockholders.

All the more remarkable is that those gains come two years after REITs were so decimated by the crash that many couldn’t even fulfill their mandates to pay dividends.

Brad Case, vice president of research for NAREIT, predicted that the “positive numbers are likely to continue for some time.” With so much value lost in those companies during the Great Recession, “there is a lot of ground to make up,” he noted.

Still, other analysts cautioned that it’s unlikely that the kinds of gains of the last two years will be repeated in 2011. As the fundamentals of the real estate economy improve, bargain buildings should be in shorter supply. Also, as interest rates climb, money for new acquisitions will be pricier.

As REITs cool their heels, the thinking goes, investors might lose interest. As a result, many analysts expect REITs to post about 12 percent returns this year.

Nonetheless, some, even those with single-digit stock prices, may still be tempting investments.

This month, The Real Deal looked at 10 REITs, and polled analysts for their informal take on whether they viewed them as “buy,” “sell” or “hold” investments.

See what they had to say below.

1. Boston Properties
Analyst consensus: “buy”

Strong, steady growth characterized Mort Zuckerman’s Massachusetts-based company in 2010. Indeed, it posted returns — the equivalent of stock price plus dividends — of almost 32 percent, well above the overall REIT average.

Its funds from operation, or FFO — a way REITs commonly measure their operating performance that’s tied to the rental income from buildings — were a sizeable $4.35 a share, according to NAREIT data; that number is expected to tick up slightly, to $4.41, in 2011.

But a more tantalizing number may be Boston Properties’ price-to-funds-from-operation ratio (P/FFO). That is the REIT equivalent of the price-to-earnings ratio used for traditional stocks.

It was relatively high in 2010, at 19.79, with an expected slide to 19.52 this year. Analysts often like lower ratios, as they generally mean shares will make back their price more quickly.

At press time, the company’s stock had closed at $92.33, which was about $6 higher than it was at the end of 2010.

The company, which owns 510 Madison Avenue and the General Motors Building, also added a prize in its own backyard at the end of 2010: Boston’s John Hancock Tower, which at $930 million was one of last year’s biggest deals. Though some worry that the notes sold to finance this transaction (and others) could saddle Boston Properties with burdensome debt, its portfolio of iconic office buildings makes it a force in the REIT world.

“They have a clear, focused strategy, to buy Class A properties in major markets, and they limit their strategy to doing just that” without overly leveraging, said Yaacov Gross, who heads the real estate securities practice at Morrison Foerster, a law firm with offices in Manhattan. “Those kinds of markets have experienced the most dramatic recovery since the downturn.”

Mort Zuckerman (left), chairman of Boston Properties, and Marc Holliday, CEO of SL Green Realty Corp.

2. SL Green Realty Corp.
Analyst consensus: “buy”

New York’s largest office landlord didn’t shy away from deals this past year, and the value of the REIT reflects that voraciousness.

Offering returns of 35 percent last year, its stock ended 2010 at $67.51 a share, while its FFO was at a robust $4.81, according to NAREIT figures.

Still, its P/FFO is set to climb in 2011, from 14.04 to 16.39, which means the inherent value of the stock should decline somewhat. Also, its dividend yield, currently at less than 1 percent, is comparatively low.

Weighing on the company’s performance, perhaps, are costs associated with buying a stake in its struggling offshoot, Gramercy Capital, for $391 million in December. That gave SL Green total control of Midtown’s Lipstick Building, as well as stakes in 2 Herald Square and 292 Madison Avenue.

Yet while those new acquisitions were costly, analysts expect them to pay off down the road for the firm, which is run by CEO Marc Holliday.

Last month, meanwhile, the landlord assumed full control of 521 Fifth Avenue, a 39-story Midtown office, by buying a 50 percent stake from the City Investment Fund.

“We think it will do very well this year,” said John Guinee, a Baltimore-based analyst with investment bank Stifel Nicolaus who follows the company. But he said SL Green derived much of its revenue this year from its structured finance business — which issues commercial loans — rather than from its property.

Still, SL Green is not afraid to push out tenants to make room for higher-paying ones, Guinee noted. “They are more aggressive than anybody else I cover,” he said.

3. Vornado Realty Trust
Analyst consensus: “buy”

The owner of shopping centers and high-rises, in addition to a neighborhood-size chunk of the Penn Station area, Vornado generated a hefty FFO last year of $5.39 from its properties, a figure that puts it ahead of rivals Boston Properties and SL Green.

But the New York-based company, which is headed by Steven Roth and Michael Fascitelli, also posted a comparatively low 23 percent stock and dividend return last year. Its share price hit a recent high in October, at $91.08, before dropping to $83.33 by year’s end.

At press time, it stood at $87.11.

Still, some analysts say Vornado’s front-runner status in terms of its FFO should be taken with a grain of salt.

The company — which has a $16 billion market cap, a measure of the total value of its outstanding shares — is so secretive and diversified that it operates almost like a hedge fund, dabbling in other companies, stocks and real estate. As a result, it’s hard to get a good read on its real estate acumen alone, according to analysts.

In addition, it’s not totally clear what future development deals will bring: The city cleared Vornado to construct 15 Penn Plaza, a 1,216-foot tower that will be close in height to the Empire State Building, but so far there’s little word about which tenants might fill the superstructure.

“They have a very opaque strategy,” Guinee said.

Late last year, The Real Deal quoted Fascitelli as saying that at times over the last few years, “being a REIT felt like being between a dog and a fire hydrant.” However, he said, REITs have since bounced back and that’s fortunately no longer the case.

4. AvalonBay Communities
Analyst consensus: “buy”

In 2006, national homeownership peaked at around 69 percent. But since then, struggling buyers have started to drift away from purchasing. And every percentage-point drop in the ownership market translates into about 1 million more renters, said Haendel St. Juste, a senior REIT analyst with investment bank Keefe, Bruyette & Woods in Manhattan.

At the same time, there’s been job growth within the 21-to-35-year-old demographic, which means those young people will be itching to get their own places soon, St. Juste explained.

Taken together, that’s good news for the Virginia-based AvalonBay, which mostly develops rental apartment complexes. While its portfolio is national, much of it is in the Northeast, with six complexes in New York, including Avalon Chrystie Place and Avalon Morningside Park. Its share price, which finished 2010 at a lofty $113, enjoyed a stunning 42 percent return last year, which may be why a handful of other analysts are also bullish on the company.

Moreover, its FFO, which was $4, is set to rise to $4.44 in 2011, according to NAREIT data. That — coupled with the company’s obvious willingness to build through recessions, which it did at its recent project in Brooklyn’s Fort Greene neighborhood — indicates that it’s well-positioned.

“We are very positive about Avalon,” St. Juste said.

5. Equity Residential
Analyst consensus: “hold”

While Avalon’s presence in the affluent Northeastern and California markets may have had an insulating effect against real estate woes, Equity Residential — the country’s largest publicly traded residential landlord — has struggled a bit more, analysts say. They attribute that struggle to the fact that the REIT, which is headed by billionaire investor Sam Zell, has 500 buildings scattered throughout a host of markets, both strong and weak.

Boasting a $14.6 billion market cap, the Chicago-based company’s New York holdings include Parc East in Murray Hill and 600 Washington Street, both luxury rentals.

The firm also bought a distressed lot last year on 10th Avenue and West 23rd Street, its first New York purchase in three years, where more than 14 stories are planned. And Zell bought 420 East 54th Street, 305 West 50th Street and 777 Sixth Avenue from Harry Macklowe about a year ago.

But despite its struggles — its revenues declined almost 8 percent in 2010, to $1.9 billion — its stock still offered almost 59 percent returns last year. However, though its FFO was $2.21 in 2010 (up from $2.12 in 2009), it’s still low for the sector, which may be why some analysts downgraded the stock last fall.

“The bigger you are, the more work it takes to move the needle,” St. Juste said. Besides, they “have a smaller development pipeline” than Avalon, which could curb market growth, he added.

6. Brookfield Office Properties
Analyst consensus: “hold”

Canada-based Brookfield is traded as a REIT in Toronto, but not in the U.S., though the entire company enjoys the tax perks of being one. That is, the firm, which owns Battery Park City’s World Financial Center and Midtown’s Grace Building, does not pay taxes on its income, because 90 percent of it is distributed back to investors.

Stateside, its stock price surged 40 percent from $12.47 a share in January 2010 to $17.53 by the close of the year, though it was stuck around there at press time.

A spin-off of Brookfield Asset Management, the company scored a huge stake in bankrupt General Growth Properties in 2010. Then, last month, it built on that stake with the purchase of another 113 million shares in the megamall operator for $1.7 billion.

It now controls 38 percent of GGP.

Fourth-quarter data was not available from the Canadian Stock Exchange by press time, but in the third quarter, Brookfield had posted an FFO of 32 cents (versus 24 cents in the year-ago quarter), so even though the values were small, there was growth. The dividend yield, another key measure, was more than 3 percent, which surpasses Boston Properties and SL Green.

7. General Growth Properties
Analyst consensus: “hold”

As was widely reported, General Growth Properties was forced into bankruptcy in 2009 before emerging late last year.

The national mall operator, which famously owned South Street Seaport before selling it to the Howard Hughes Corporation in November, saw its stock price finish the year at a weak $15.48. And it’s dipped even lower since then, coming in at $14.88 at press time — a significant drop from its recent $17.75 high on Nov. 5.

For most of the first quarter of 2010, the company was delisted from the New York Stock Exchange because of its bankruptcy. In addition, other companies, like Brookfield (see above), continue to pick at its remains.

Meanwhile, the company posted an FFO loss last year of 12 cents a share, though it is expected to climb to 97 cents in 2011.

Similarly, its P/FFO, which was negative 129 in 2010, is expected to leap to 15.96 this year — a stunning 908 percent increase — so the opportunity to buy low and sell high is ripe.

Still, the company has had a startling downfall.

8. iStar Financial
Analyst consensus: “hold”

Also with projected negative FFO growth is troubled lender iStar, run by Jay Sugarman. The company trades in the small subset of mortgage REITs, which don’t own properties outright.

While some REITS suspended dividends in the annus horribilis of 2008, iStar has not paid them in the two years since 2008, which is allowed under tax laws if a firm incurs losses and it has no taxable income.

As The Real Deal has reported, loans on a number of iStar’s properties are troubled or currently facing foreclosure proceedings, including One Madison Park, 49 East 34th Street and 20 Bayard.

The firm had a $7.82 share price at the end of last year, up about 300 percent from its 2010 low. At press time, it was up to $8.06 a share.

And last month, the Wall Street Journal pointed out that the company has been successful in selling off its assets and reducing its debt level. The paper also noted that its stock was trading below $1 in February 2009.

So its improvement has given at least one analyst cause for hope.

“The jury is out in terms of what will happen with that company,” Morrison Foerster’s Gross said. “It’s managed by some very clever people, so betting against them is a bad idea.”

Officials from iStar did not return calls.

9. Apollo Commercial Real Estate Finance
Analyst consensus: “buy”

New York-based Apollo is another mortgage REIT that dabbles in first mortgages and commercial mortgage-backed securities. But with its share price barely budging, the firm did not give its investors much to cheer about last year. In fact, at press time, its stock price was $16.36, which is about where it was all year. Likewise, its FFO was 95 cents in 2010, though it is expected to inch up to $1.29 this year.

The small, $289 million market-cap firm was founded in 2009 as an offshoot to the powerful private equity group Apollo Management. Its REIT, though, is also fairly young, so it may be too soon to fully assess it.

But the company offers a generous 10 percent dividend yield despite its poor stock showing — or, more precisely, because of it. That payout seems to set it apart from other REITs. Its P/FFO was 17.21 in 2010, headed down to a strong 12.67 in 2011.

“I think these guys offer a pretty compelling value proposition,” said Josh Barber, a Stifel analyst.

Last year, it borrowed $24 million from JPMorgan to finance a 155-room Midtown hotel, according to an earnings statement. The firm also has taken advantage of $306 million in federal Term Asset Relief Fund bailout money to fund its portfolio.

10. Gramercy Capital Corp.
Analyst Consensus: “sell”

Tiny as REITs go — with just a few hundred employees — and focused on loans, Gramercy saw its share price reduced to almost pennies last year. That was primarily because it got hammered over bad loans. Other financial indicators were also grim.

Though year-end totals were not available at press time, in the third quarter of 2010, the firm’s FFO was a measly 41 cents, which was actually up from a loss of $3.57 in the year-ago period. But then in December, a mini-bailout arrived in the form of parent firm SL Green, which swooped in to snap up shares of some of Gramercy’s signature properties, like Manhattan’s Lipstick Building.

The markets seemed to like that the firm was thrown a lifeline. Gramercy’s shares were up 22 percent, but their price still stood at just over $3 last month, which is a far cry from other high-flying REITs.

For his part, Gross said the firm desperately needs to be restructured, or more lifelines will have to be thrown in 2011.

It and SL Green “have been very connected at the hip,” he said. “The idea that they would let it collapse doesn’t seem viable.”