(Top buy-rated real estate stocks for 2011 report updated with AvalonBay Communities acquisition activity.)
NEW YORK (TheStreet) — Stocks in the real estate investment trust sector outperformed the S&P 500 in 2010 and are expected to deliver 9% to 11% in total returns in 2011, according to analysts at Keefe, Bruyette & Woods.
Morningstar(MORN_) noted that REITs have been catching on with a number of exchange-traded fund investors who consider them as potential hedges against inflation. The investment research firm pointed to inflows of $312 million to the iShares Dow Jones U.S. Real Estate(IYR_), and $371 million of net inflows to the Vanguard REIT Index(VNQ_) in the third quarter as evidence of the growing interest in REITs.
REITs have a distinct advantage over broader market investing, Greg Genovese, president and CEO of Pacific Valley Realty Capital, told TheStreet recently. He said the group’s rise is due in part to the equities’ ability to generally offer better yields and cash flow than dividend-paying stocks. There is simply more demand for REITs nowadays as well, he said, and that demand continues to increase.
McGrath said equity REITs stand to benefit in 2011 from “superior access to attractively priced capital” as fundamentals stabilise following the “sharp decline” the sector faced amid the Great Recession. She expects multifamily and hotel sector REITs to rebound with the strongest internal growth over the next two years, and advised REIT investors in 2011 “to focus on REITs and sectors that can deliver both core portfolio and external growth.”
Funds from operations — or FFO, a performance figure used by REITs to define cash flow from operations, removing the profit-reducing effect of depreciation — should grow between 7% and 9% annually on average over the next few years. KBW’s calls assume real GDP growth of 2.6% in 2010, decreasing 1.3% in 2011, with unemployment remaining above 9% throughout 2011 and the Fed Funds rates unchanged through the year at 0% to 0.25%.
Genovese added that the REIT sector as a whole has not yet fully recovered from its highs before the recession, offering greater upside potential for investors in the space because “the blood has already been spilled and the liquidity crisis is no longer what it was.”
With all this in mind, here then is a roundup of KBW’s top buy-rated REIT picks for 2011.
Alexandria Real Estate Equities
Alexandria Real Estate Equities(ARE )Company Profile: Alexandria Real Estate Equities is a Pasadena, Calif.-based REIT focused on science-driven cluster formation through the ownership, operation, management & selective redevelopment, development & acquisition of properties containing office/laboratory space.
KBW’s Price Target: $79
Market Cap: $4 Billion
Dividend Yield: 2.6%
KBW expects the struggling labour market to continue to pressure occupancy and rent growth in the office REIT space, though restrictive lending for new construction and little new supply should help the subsector rebound at a quicker pace.
McGrath noted that that Alexandria Real Estate has lower-than-average current vacancy and said central business district (CBD) and specialty office REITs can expect better rent growth than their suburban office peers.
She said Alexandria Real Estate is a “high-quality life science office laboratory REIT with a concentration of assets in critical life science markets” such as San Francisco, Cambridge, Washington and San Diego.
“We view ARE’s concentration in life science and lack of exposure to financial tenants as a positive, and its solid core portfolio results throughout 2010 has affirmed our thesis that life science will outperform traditional office spaces,” the analyst noted. “Its East River project in Manhattan has positive momentum, and we favour the niche focus where demand is less impacted by the current economy.”
McGrath also highlighted Corporate Office Properties Trust(OFC ), a Columbia, Md.-based REIT which focuses mainly on strategic customer relationships and specialised tenant requirements in the US Government, defence information technology and data sectors.
OFC underperformed in 2010 and is poised to rebound in 2011, she predicted. “We believe OFC may have a quarter or two of proving the story after confidence was shaken with lower guidance and slower leasing progress,” adding that “with the recent news of cyber attacks on credit card websites, we believe OFC may see a sense of urgency by the government on additional cyber security initiatives.
Alexandria Real Estate raised its quarterly cash dividend by 10 cents, or 28.6%, to 45 cents per share in early December. Analysts from JPMorgan issued an overweight rating and $76 price target on ARE shares.
AvalonBay Communities(AVB )
Company Profile: AvalonBay Communities is an Arlington, Va.-based REIT engaged in the development, redevelopment, acquisition, ownership and operation of multifamily communities in barrier-to-entry markets of the United States.
KBW’s Price Target: $138
Market Cap: $9.59 Billion
Dividend Yield: 3.18%
The Great Recession pressured rent and occupancies in the multifamily and apartment REIT space, dragging revenue and net operating income as well, but McGrath said “improving consumer sentiment, unbundling of pent-up demand, and declining homeownership rates have ‘jump-started’ a resurgence” in demand that could carry through until 2013.
KBW’s top pick in the space is AvalonBay, favouring the subsector based on improving fundamentals and absence of new net supply over the next couple of years. “Within the sector, we view AVB as a core holding for investors, given its cohesive, experienced management and a proven track record of generating above-average core growth and shareholder returns,” the analyst noted. “AVB sports a best-in-class balance sheet and a high-quality portfolio concentrated in high barrier-to-entry coastal markets with above-average long-term growth prospects.”
McGrath added that AvalonBay is “a savvy developer with a sizable pipeline, a factor that should increasingly add value as fundamentals continue to improve and should help AVB generate above-average prospective FFO and net asset value growth.”
Earlier this fall AvalonBay CEO Blaire Bryce divested 97,431 AVB shares for a total price of around $10.6 million.
In November analysts from Bank of America/Merrill Lynch lifted their price target on AVB shares by $1 to $117 and reiterated a buy rating, citing management’s belief in strong demand/supply fundamentals over the next few years.
In early January, AvalonBay announced the acquisition of three apartment communities, two in California and one in New Jersey.
The acquisitions were made over the past three months for a total purchase price of $189.3 million, all purchased through AvalonBay Value Added Fund II, a private, discretionary investment vehicle in which AvalonBay has a 31% equity interest.
The recent acquisitions bring the fund’s total purchase count to nine communities consisting of 3,936 apartment homes for a total acquisition cost of $569 million. The fund’s objective is to create value through redevelopment, enhanced operations and/or improving market fundamentals.
Forest City Enterprises
Forest City Enterprises(FCE.A )Company Profile: Cleveland, Ohio-based Forest City Enterprises is engaged in the ownership, development, management and acquisition of commercial and residential real estate and land throughout the United States.
KBW’s Price Target: $22
Market Cap: $2.56 Billion
Dividend Yield: 0.0%
Portfolio co-managers Marty Whitman and Ian Lapey of Third Avenue’s flagship Third Avenue Value Fund recently trimmed their holding in Forest City.
RealMoney contributor Sham Gad recently wrote that while land-rich companies like Forest City Enterprises pose interesting value bets, the quality of the balance sheet could not be relied on in times of distress.
RBC Capital Markets reiterated a sector perform rating and $14 price target on the stock in December. Oppenheimer analysts had an outperform rating and $38 price target, according to Briefing.com.
RealMoney contributor Tim Melvin likes Forest City as a play in distressed investing. Like Gad, Melvin watches the moves of successful distressed-stock investors like Marty Whitman, and also looks to Wilber Ross.
“I think we are going to see a lot more situations like Forest City bonds, which have tripled since the first of the year while maintaining current coupon payments,” Melvin wrote last summer. “I have been around the markets more years than I will confess, and I have never seen yield-seeking end any way but badly. When the market comes back, debt issued by companies like Greenbrier(GBX ) and Sealy(ZZ ) are going to be interesting.
On Dec. 28, Forest City senior vice president and chief accounting office Linda M. Kane sold 947 company shares at $16.20 per share for a price of $15,337.
Glimcher Realty Trust
Glimcher Realty Trust(GRT ) Company Profile: Columbus, Ohio-based Glimcher Realty Trust is a self-administered and self-managed real estate investment trust, which owns, leases, manages and develops a portfolio of retail properties consisting of enclosed regional and super regional malls and community shopping centres.KBW’s Price Target: $9
Market Cap: $691.5 million
Dividend Yield: 4.9%
KBW noted that mall and outlet centre equity REITs outperformed the equity REIT total return and the S&P 500 in 2010. “Lower-quality, higher leverage” names led the group, names such as Glimcher Realty, CBL & Associates(CBL ) and Pennsylvania REIT(PEI ).
Meanwhile, firms like Taubman centres(TCO ), Macerich(MAC ), Simon Property Group(SPG ) and Tanger Factory(SKT ) — REITs that own higher-quality malls and outlet centres, and boast more conservative balance sheets — lagged though still delivered “impressive” results.
McGrath said that despite high unemployment, shoppers returned to malls in 2010 helping to stabilise tenant sales and fundamentals for mall REITs.
KBW’s top picks in the mall subsector were Glimcher and Westfield Group(WDC.AX ). “Recent steps to upgrade portfolio quality should continue to pay dividends for Glimcher — we believe pro forma tenant sales fall in the $370-$380/square foot range, versus $354/sf currently, with the recent acquisition of its partner’s share of Scottsdale Quarter (potentially $600/sf centre upon stabilisation), joint venture acquisition of Pearlridge centre (roughly $500/sf) and addition of unusually high sales productivity tenants” such as Apple(AAPL ) stores.
“We believe Glimcher is well on its way to further distancing itself from the ‘low quality, higher-leverage’ peer group,” the firm added. “Westfield recently announced plans to spin off 50% interests in nearly all of its Australia and New Zealand centres into a separate company. We believe relatively greater exposure in the early innings of improving U.S. and U.K. retail markets, while at the same time de-risking its largest development at Stratford City (U.K.) and creating a new fee-paying joint venture partner, could be catalysts that finally get the stock moving after underperforming its U.S. mall peers this year.”
Late on Jan. 4, Glimcher issued two statements about executive changes.
Glimcher tapped Thomas J. Drought as its new executive vice president and director of leasing. Drought began his career at Glimcher in 1997 and has held several positions since then. Most recently he was senior vice president, director of leasing.
Damion Sankovich was promoted to vice president of leasing. He joined Glimcher in 2004 and served most recently as the REIT’s regional director.
Hersha Hospitality Trust
Hersha Hospitality Trust (HT )
Company Profile: Harrisburg, Pa.-based Hersha Hospitality Trust is a real estate investment trust that invests in institutional grade hotels in central business districts, suburban office markets and stable destination and secondary markets in the Northeastern United States and select markets on the West Coast.
KBW’s Price Target: $7
Market Cap: $1.12 Billion
Dividend Yield: 3%
Lodging REITs easily outpaced the S&P 500 in 2010, returning 44.1% and just over 14%, respectively. Strategic Hotels & Resorts(BEE ) led the group’s runup, returning nearly 170%, followed by Ashford Hospitality(AHT ) at 118% and Hersha Hospitality at 106.7%. Recent lodging IPOs such as Chatham Lodging(CLDT ), Pebblebrook Hotel Trust(PEB ) and Chesapeake Lodging(CHSP ) underperformed in 2010.
RevPAR — or revenue per available room, a closely watched metric in the hotel and lodging industry — grew progressively throughout 2010. The metric also benefited from easier comparisons since 2009 revPAR declined 18.5%, as well as from the return of business travellers and a rebound in leisure travel. Higher occupancies offset modest declines in average daily rates, KBW reported, with demand largely stabilizing. McGrath forecast revPAR improvement between 5.5% and 6.5% in 2011, driven by higher rates. Supply growth is expected to be negligible, leading demand to outpace.
“We believe Hersha will continue to benefit from its exposure to New York City and other northeast markets, and expect the company will continue to make accretive acquisitions over the next several quarters,” KBW noted. “We favour Strategic Hotels’ leverage to the luxury chain scale, which should continue to outperform in the current recovery.”
McGrath added that lodging names with heavy exposure to central business districts in gateway cities like Boston, New York, Philadelphia and Washington will outperform.
KBW also has an outperform/rating on Hospitality Property Trust(HPT ).
Lexington Realty Trust
Lexington Realty Trust (LXP )
Company Profile: New York City-based Lexington Realty Trust is a self-managed and self-administered Maryland statutory real estate investment trust which acquires, owns, and manages a geographically diversified portfolio of net leased office, industrial and retail properties.KBW’s Price Target: $9.50
Market Cap: $1.09 Billion
Dividend Yield: 5.7%
Like Alexandria Real Estate, Lexington Realty Trust should benefit as restrictive lending for new construction and little new supply help the office and industrial REIT subsector rebound at a relatively quicker pace.
Office REITs’ 18.3% return in 2010 underperformed the equity REIT group’s total return of nearly 25% in 2010, but outperformed the S&P 500 in the time period.
Piedmont Office Realty Trust(PDM ), another recent IPO, easily outpaced with a return upwards of 42%, leading the group higher along with MPG Office Trust(MPG ), SL Green Realty(SLG ) and Boston Properties(BXP ).
Lexington Realty said in December it planned to sell 10 million common shares in a secondary public offering, hoping to raise $77 million. It sold the shares at $7.70 a piece, a 4.3% discount to the stock’s closing price a day prior.
Lexington Realty said it would use the proceeds to repay debt and for general corporate purposes.
In November Lexington Realty increased its dividend by 15% to 11.5 cents per share. The higher dividend will be paid Jan. 14, 2011 to holders of record on Dec. 31.
Ramco-Gershenson Properties Trust
Ramco-Gershenson Properties Trust(RPT )
Company Profile: Ramco-Gershenson Properties Trust is a Farmington Hills, Mich.-based real estate investment trust, which is engaged in the business of owning, developing, acquiring, managing and leasing community shopping centres, regional malls and single tenant retail properties.
KBW’s Price Target: $13
Market Cap: $465.2 Million
Dividend Yield: 5.3%
Shopping centre REITs outperformed the S&P 500 in 2010, save for Cedar Shopping centres(CDR ), the only shopping centre REIT to turn negative with a return of -3.6%. Developers Diversified Realty(DDR ), Saul centres(BFS ) and Kite Realty Group(KRG ) led the performers while relative laggards included Acadia Realty Trust(AKR ), Equity One(EQY ) and Inland Real Estate(IRC ).
Vacancy rates are expected to edge up to 11.5% in 2011, before falling back to 11.4% in 2012 and 10.7% in 2013, according to Reis. Those vacancies pressure mall owners’ rent growth which is not expected to turn positive until 2012.
KBW tapped Ramco-Gershenson Properties as its top pick in the shopping centre space.
“RPT has made meaningful improvements to its balance sheet over the past year, reducing leverage to ~55% and debt-to-earnings before interest, taxes, depreciation and amortization to 8.0x. RPT has also taken steps to improve its corporate governance, which we believe warrants a higher valuation premium (smaller discount) than in past years. RPT is attractive on a relative valuation basis, trading at 10.6x our estimated 2011 FFO, or a 25% discount the sector average, and at a 17% discount to our $14 net asset valuation estimate — which represents the largest discount in the sector. “
McGrath added that Ramco-Gernshenson’s “9.5% implied cap rate is among the highest in the sector, and well above the 7.7% sector average.”
Company Profile: Jacksonville, Fla.-based Rayonier is an international forest products company, which is engaged in activities associated with timberland management, the sale and entitlement of real estate, and the production and sale of high value specialty cellulose fibres and fluff pulp.KBW’s Price Target: $57
Market Cap: $4.28 Billion
Dividend Yield: 4.1%
Timber REITs outperformed both the overall equity REIT market and the S&P 500 in 2010, though Rayonier outpaced the group with a total return of 29.8%. Timber peer Potlatch(PCH ) returned 6.7% while Plum Creek(PCL ) returned just 2.3%.
KBW noted that timber REITs limited harvest volumes as much as 30% below sustainable outputs in 2010 as a means of maximizing trees rather than selling into a depressed market. As such, the research firm expects 25% growth in EBITDA for the year despite profits remaining 50% below peak levels in 2005 and 2006.
McGrath said November housing starts — which ticked up a better-than-expected 3.9% to a seasonally adjusted annual rate of 555,000 yet remain 5.8% below year-earlier rates — need to reach 1 million “before we see a meaningful increase in sawlog pricing.”
With the supply of unsold new-home inventories near 10-months, she doesn’t expect a housing recovery until 2012, meaning 2011 estimates are still too high and are likely to decline, and that dividend payments are likely to remain under pressure.
In October Rayonier increased its quarterly cash dividend by 8% to 54 cents per share. The higher dividend will be paid Dec. 31 to shareholders of record on Dec. 10.
In early December analysts from Stifel Nicolaus initiated coverage of the forestry products and timberland REIT with a buy rating and $60 price target. Wells Fargo initiated coverage of Rayonier in the week prior, also giving it a buy rating and $60 price target. On Jan. 4, 2011 Rayonier director Paul Kirk sold 1,000 company shares at $55.62 per share for $55,620.
Starwood Hotels & Resorts Worldwide
Starwood Hotels & Resorts Worldwide(HOT )
Company Profile: White Plains, N.Y.-based Starwood Hotels & Resorts Worldwide operates hotel and leisure business both directly and through its subsidiaries. Its brand names include St. Regis, The Luxury Collection, W, Westin and Le Meridien.
KBW’s Price Target: $62
Market Cap: $11.69 Billion
Dividend Yield: 0.5%
As previously mentioned in regards to Hersha Hospitality, lodging REITs easily outpaced the S&P 500 in 2010, returning 44.1% and just over 14%, respectively. RevPar is expected to grow between 5.5% and 6.5% in 2011, driven by higher rates. With supply growth expected to be negligible, demand should outpace.
McGrath said that lodging names with heavy exposure to central business districts in gateway cities like Boston, New York, Philadelphia and Washington will outperform. That bodes well for Starwood which has Sheraton, St. Regis and W in a number of major metropolitan cities across the U.S.
In Early December Starwood said it expects annual per-share earnings growth of 35% to 42% through 2013. EBITDA is expected to increase 14% to 18% a year for the next three years, the company added. Excess cash flow will come in at $1.7 billion to $2.2 billion over the same three years. Starwood’s forecasts assume a normal cyclical recovery with annual worldwide revenue per available room increases of 7% to 9% through 2013.
The hotel company said it is “well-positioned to take advantage of the robust RevPar growth occurring in emerging markets.”
In November Starwood announced a 50% increase to its annual cash dividend, saying it would pay 30 cents per share on Dec. 30 to shareholders of record on Dec. 16.
On Dec. 27 President and CEO Frits D. Van Paasschen sold 230,926 company shares at $60.33 per share for $13.9 million.
On the same day he exercised options for another 200,000 shares at $11.39 per share for $2.3 million. He still retains around 130,025 shares.
DCT Industrial Trust
DCT Industrial Trust(DCT )
Company Profile: DCT Industrial Trust is a Denver, Colo.-based real estate company which owns, operates and develops high-quality bulk distribution and light industrial properties in high-volume distribution markets in the U.S. and Mexico.
KBW’s Price Target: $6
Market Cap: $1.14 Billion
Dividend Yield: 5.3%
Global economic concerns pressured industrials in recent years leading industrial REITs to underperform the REIT peers yet the group outpaced the S&P 500 in 2010.
KBW noted that First Industrial(FR ) led the group’s gains with a total return of nearly 59%. First Potomac(FPO ) followed with a return of 32.4%. Terreno Realty(TRNO ), which began trading publicly through an IPO in February, was the lone negative performer with a return of -8.2%.
Sluggish global trade pressured the sector but demand is recovering, KBW said, and despite weak supply/demand rents and overall vacancy appear to have already bottomed.
McGrath said that as the world economy improves, the industrial sector could be among the first to benefit as occupancy is correlated with GDP growth. She expects industrial earnings to “modestly improve in 2011 and more robustly in 2012.”
The analyst highlighted DCT Industrial, saying that “although the company will continue to be negatively impacted by weak economy, it has the balance sheet strength to navigate through this challenging market and emerge as a beneficiary with external growth opportunities over the next several years.”
She added that DCT’s 86.9% occupancy remains below stability “which we believe should allow for more potential upside as markets recover.” McGrath also said that “DCT’s internal growth profile can surprise on the upside by driving occupancy and acquisition opportunities are starting to emerge.”
On Jan. 5, DCT announced the acquisition of nine properties in Southern California with a total value of $79.5 million.
DCT said the acquisition will be acquired through three transactions, including one for the controlling interests in five distribution facilities, a second for three cross-dock truck terminals and a third for a single bulk distribution building. DCT said the combined purchase price is between 15% and 20% below estimated replacement costs while the in-place rents for the truck terminals are 30% to 40% below estimated current market rents for similar facilities.
The total price reflects an average of $57.50 per square foot value for the distribution buildings and $126,900 per door value for the truck terminals.
The first year cash yield is expected to average 7.5% with the buildings 97.5% leased at acquisition.
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