The Zacks Analyst Blog Highlights: Public Storage, Simon Property Group, Avalonbay Communities, UDR and HCP

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Jan 04, 2012, 09:30 ET

CHICAGO, Jan. 4, 2012 /PRNewswire/ -- Zacks.com announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include Public Storage (NYSE: PSA), Simon Property Group Inc. (NYSE: SPG), Avalonbay Communities, Inc. (NYSE: AVB), UDR Inc. (NYSE: UDR) and HCP Inc. (NYSE: HCP).

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Here are highlights from Tuesday's Analyst Blog:

Are REITs a Safe Haven in 2012?

Investors looking for high dividend yields have historically favored the REIT sector. Solid dividend payouts are arguably the biggest enticement for investors as the U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders.

By the end of 2011, the average dividend payout ratio for all listed REITs was 70% of FFO (funds from operations), implying that REITs are likely to maintain dividends and potentially increase them in future with further improvement in market fundamentals. Funds from operations, a widely used metric to gauge the performance of REITs, are obtained after adding depreciation and other non-cash expenses to net income.

The dividend yield for the FTSE NAREIT All REIT Index by the end of third quarter 2011 was 5.2% compared with 1.9% for the 10-year U.S. Treasury Note. The relatively low yield for the U.S. Treasury Note was fallout of a U.S. rating downgrade. In August 2011, credit rating agency S&P had downgraded the U.S. credit rating for the first time since granting it in 1917, from a AAA rating to AA-plus citing concerns about the nation's budget deficits and burgeoning debt burden.

In order to stimulate the economy, the U.S. Federal Reserve embarked on 'Operation Twist' in September, under which it sold short-dated U.S. government debt and instead bought longer-dated paper. This, in turn, plummeted the yield for the U.S. 10-year bonds to as low as 1.67%, which inched up to 1.87% at year-end 2011.

Besides, among the various positives, REITs are historically considered to have a low correlation with equities, implying that they do not normally move in the same direction as equity stocks or bonds. More often than not, when stock prices are down, REITs tend to perform better, thus balancing the performance of the overall equity portfolio.

Consequently, as an asset class, REITs offer more diversification to the equity portfolio providing a competitive long-term return. Furthermore, REITs are currently trading at a discount to their Net Asset Value (NAV) and are therefore considered inexpensive. As of October 5, 2011, REITs were trading at a 12% discount to NAV.

A combination of factors has helped the listed REIT market to stand out and gain critical mass over the past 15 to 20 years. These have led to transparency and real-time price discovery for REITs, which have helped to mitigate risks. During 2007 to 2009, REITs took on far less debt than private real estate investors, and many were able to sell at the top of the market when private equity investors were still buying.

Importantly, during the downturn, REITs were able to acquire properties from highly leveraged investors at deeply discounted prices. This enabled them to add premium high-return assets to their portfolios.

Furthermore, REITs managed to raise capital to pay off debt, owing to a large inflow of funds as institutional investors allocated more 'dry powder' to the industry, thereby becoming increasingly attractive investment propositions. For the first nine months of 2011, REITs raised $43.4 billion in equity and was well on course to either match or surpass the $47.5 billion in equity raised in 2010.

Furthermore, according to data from NAREIT, the leverage ratio of listed REITs (total debt against market capitalization) as of September 30, 2011 was 38% – significantly lower than 51% at the end of second quarter 2008 prior to the Lehman Brothers collapse. In addition, REITs typically have a large unencumbered pool of assets, which could provide an additional avenue to raise cash during a crisis. Consequently, REITs are comparatively better equipped to continue outperforming the broader market.

As of December 30, 2011, the total return of Self-Storage REITs were 35.22% (as measured by the FTSE NAREIT Equity REIT Index), followed by Regional Malls (22.00%), Residential (15.37%), and Health Care (13.63%). As such, we remain bullish on Public Storage (NYSE: PSA) – the largest owner and operator of storage facilities in the U.S.; Simon Property Group Inc. (NYSE: SPG) – a leading mall REIT; Avalonbay Communities, Inc. (NYSE: AVB) – one of the best-positioned apartment REITs; UDR Inc. (NYSE: UDR) – a leading multifamily REIT; and HCP Inc. (NYSE: HCP) – a leading healthcare REIT.

Moving forward, limited supply of new construction coupled with the growing demand for high-quality properties bode well for the earnings prospects of REITs, in particular those that have assets in high barriers-to-entry markets. According to reports, new construction is currently averaging 390 million square feet per year, compared to 1 billion square feet per year in the decade prior to the global financial crisis. As a result, REITs are now heavily dependent on inorganic growth to fuel their expansion drive. This could also help the overall industry with significant market consolidation.

To sum up, we firmly believe that despite a few pitfalls, REITs still make a worthy investment proposition in 2012.

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