Global Economic Concerns Weaken Demand for Commercial Space, With Hotels Faring Worst; ‘It’s Pretty Dismal’
For much of the past two years, real-estate stocks outperformed the broader stock market. But that trend ended during the fall as investors grew increasingly fretful that a weak global economy would sap demand for commercial space.
The Dow Jones All Equity REIT Index, which tracks the stock of 130 companies, posted a negative 15% total return during the third quarter, an about-face from the second quarter when the REIT index registered a 2.9% gain.
The third-quarter return was the largest drop since the first quarter of 2009, when the index posted a negative return of 31%, and was the second time since late 2009 that REITs put in a weaker performance than the Standard & Poor’s 500-stock index. During the third quarter, the S&P 500 posted a negative total return of 14%.
Jim Sullivan, a managing director of REIT research at Green Street Advisors, said REITs did worse than the overall stock market as investors fled from “stocks that are economically sensitive.” He said investors began dumping property stocks in August following a weak jobs report, poor housing data and Europe’s percolating debt crisis.
Prior to the third quarter, REITs were thought to be immune from the turmoil of Europe’s debt crisis and unrest in the Middle East. Investors viewed property stocks as safe havens and were attracted to REITs for their high dividend yields, which are averaging 4%.
Now, Wall Street is having second thoughts on how protected REITs are from the global malaise. Although rent growth and occupancy levels are improving for all commercial properties—office, hotels and retail—investors worry that a global slowdown could tip the U.S. into a double-dip recession. This will hurt the ability of commercial landlords to raise rents in the future and sign new leases amid weaker trade, travel and jobs growth.
Investors are concerned that “if the global economy is weak, then there is not as much…demand for industrial facilities…[and] hotels. And, it means employment is going to be weaker,” making it harder for some office landlords to boost occupancy, said Brad Case, senior vice president of research and industry information at the National Association for Real Estate Investment Trusts.
REITs that own and manage hotels, industrial space and office buildings posted the worst returns during the third quarter of negative 32%, 24% and 19%, respectively.
“It’s pretty dismal,” said David Loeb, a lodging analyst at Robert W. Baird.
Hotels usually get hit faster and harder than most property types during a down economy as travelers cut back quickly. Other property types benefit from having longer-term leases.
Mr. Loeb says investor concerns are likely overdone. “I don’t see a change in fundamentals yet and I don’t see any reason to lower expectations…because travel patterns haven’t changed,” he said. “In fact, group booking…continues to grow.”
Mr. Loeb said investors were selling hotel stocks of REITs weighed down by debt like FelCor Lodging Trust, a heavily indebted company that saw its stock price plunge 56% drop during the quarter. He said the company was the worst performing individual REIT during the quarter in his coverage area. And he noted that FelCor, based in Irving, Texas, has been trying to sell assets to help pay its preferred dividends.
“I think there are concerns among investors they may not get the prices they want,” for those properties, Mr. Loeb said.
Virtually all REIT sectors posted declines in the third quarter. Manufactured homes, which are partially built off-site, felt the least pain and dipped just 0.73%. Mr. Sullivan said investors have been gravitating toward manufactured homes because the sector has stable cash flows. Owners of manufactured homes, which include trailers, own the property but pay rent for the use of land.
“If [the tenant] stops paying the rent, they either lose their home or they have to move their home to another community,” Mr. Sullivan says. “Rent is one of the last things they stop paying.”
For the first half of the year, the Dow Jones Equity All REIT Index was up 9.9% compared with a 6% rise in the S&P stock Index, on a total return basis. That performance followed a two-year period in which REITs returned nearly 30%.