REITs Boom As More Industries Discover This Tax-Friendly Structure

Income investors should take a moment to thank President Dwight D. Eisenhower. It was Ike who signed into law the Cigar Excise Tax Extension of 1960, which included an amendment that gave small investors a chance to directly participate in the returns generated by diversified portfolios of income-producing real estate. Up until then investing in things like hotels and apartment buildings was strictly a big money institutional game.

The law mandated that real estate investment trusts pay out no less than 90% of their income to their investors as taxable dividends. REITs in turn got to exempt that income from corporate taxes. Today there are 129 equity REITs representing a combined market cap of more than $500 billion.

It’s been a great source of income and total return for investors for decades. Over the last ten years the Dow Jones U.S. Real Estate Index (IYR), comprised almost exclusively of REITs, has beaten the S&P 500 return by 80%. Since the depths of the financial crisis in early 2009 REITs have returned more than 220%.

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Now, 50 years after REITs’ inception, the industry is buzzing again. A generation of boomers craves income, and more and more companies have become wise to tax and other advantages of the REIT structure. Everyone wants to get in on the REIT bonanza, as operating businesses from cellphone towers to timber companies, billboard firms and private prisons are converting to REITs.

Initially the REIT approach to real estate investment, as established by Congress, contemplated land and the improvements on it. At least 75% of REIT income needed to be derived from real estate, typically in the form of rent. But lately that definition of “rent” has become as loose as getting paid to store, manage and retrieve documents, as pending REIT convert Iron Mountain argues.

Here is how Iron Mountain rationalizes its reawakening as a REIT. “The foundation of Iron Mountain’s business is renting space to enterprises for the storage of their physical records. … Storage rental is the primary driver of our revenues, profits and cash flows. As such, we operate a substantial real estate network comprising more than 64 million square feet across nearly 1,000 storage facilities.”

Since Iron Mountain announced its intention to become a realty trust in early June, its stock has appreciated 38%, quintupling the total return of the S&P 500. Assuming the IRS approves Iron Mountain’s application, it should be a full-fledged REIT by January 2014.

Lumber company Weyerhaeuser became a REIT in 2010. Since its conversion its total return, comprising stock appreciation and dividends, has far exceeded close competitors and the market.

Recent IRS rulings, including one issued in October 2011, have potentially opened the door for billboard REITs. The rulings found that billboards and sign superstructure are real property even if the signs are just bolted to a building.

Suddenly Lamar Advertising, one of the largest outdoor advertising firms, has announced plans to pursue REIT status. Never mind any notion that Lamar’s core competency was providing advertising solutions. Real estate pays better dividends. “We believe the REIT structure would be a natural fit for us. At the core we provide real estate and real-estate-related services to advertisers,” says Chief Executive Sean Reilly.

Data center companies Equinix and Cincinnati Bell-owned CyrusOne have also said they are exploring REIT status. They would join three existing data center REITs: Digital Realty Trust, ?DuPont Fabros Technology and ?CoreSite Realty, expanding this industry segment, which provides storage space for the growing Internet cloud.

Soon prison owners like Corrections Corp. of America may go REIT, as will energy-related property owners, owners of sports venues and solar farms.

The expanding REIT industry is great news for yield-hungry investors because it gives them a chance to create a diversified portfolio of income generators from nearly every sector of the economy. In the case of solar energy, for example, REITs may actually represent a smarter way to play the sector.

Tom Konrad, editor at AltEnergyStocks.com, explains, “Currently the only way a small investor can invest in solar is by buying stock in solar manufacturers.” He argues that fierce competition makes solar manufacturers a bad investment.

Indeed, since its inception in April 2008 Guggenheim’s Solar ETF (TAN) has fallen 94%, while solar installations have grown sixfold and costs have plummeted.

Adds Konrad, “While falling costs destroy manufacturer margins, they improve the opportunities for solar farms.”

So far the IRS has not ruled on whether solar farms would qualify as REITs. That hasn’t kept California industrial REIT Prologis from entering the business. IRS rules allow REITs to generate up to 25% of their income from sources other than real property, and this would allow some solar on REIT-owned buildings.

Prologis plans to equip 10% of its 600 million square feet of industrial roof space with solar photovoltaic panels. Andrew Duffy, portfolio manager with Ascent Investment Advisors, warns against being blinded by REIT dividends. Says Duffy, “Focus on whether you like the company’s business for the long term. At the end of the day, qualifying as a REIT isn’t going to magically transform a weak business model into a strong one.”

Jens Nordvig, Nomura Securities

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By Brad Thomas

Taken from: http://www.forbes.com/sites/bradthomas/2012/11/26/reits-boom-as-more-industries-discover-this-tax-friendly-structure

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‘No Better Time’ to Buy: REITs Now Invest In Foreclosed U.S. Homes

You want to bet on the U.S. housing marketing turning around, but you’re not ready to buy a retirement property. There’s a new vehicle developing for just that type of investment.

The next wave of real estate investment trusts south of the border is likely to be made of distressed properties bought by private-equity investors so cheaply that they can be rented out and still produce good returns despite the high management costs. This asset class does not exist now among REITs, which, in terms of rental properties, has been restricted to apartment buildings.

Since last spring, Toronto-based Tricon Capital Group has accumulated a portfolio of about 700 houses for about US$80-million in various U.S. locations. Blackstone Group LP has spent about US$300-million to buy more than 2,000 foreclosed homes. Beazer Homes USA has created Beazer Pre-Owned Rental Homes Inc., backed by private-equity firm Kohlberg Kravis Roberts & Co.

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David Berman, chief executive of Tricon Capital, says unlike vacation properties, there is nothing romantic about his investments — it’s all about the numbers.

“There’s no emotional attachment,” says Mr. Berman with a laugh. “We are buying workforce housing where real people need to live. There are people who owned their houses before and are now forced to rent.”

His company has been purchasing properties one or two at a time in places like California, Arizona and Florida. “Sometimes we are buying on the steps of the courthouse,” said Mr. Berman.

There’s no emotional attachment The math works because his company has been buying out of foreclosure for as low as 40¢ on the dollar compared to where home prices were at the peak of the U.S. housing market in 2006. That’s probably about 10 percentage points better than he would get through normal channels like the Multiple Listing Service, says Mr. Berman.

“The reason we can do it is we are paying cash and we [deliver it] in 24 hours,” said Mr. Berman, adding Tricon is funding the acquisitions from the company’s balance sheet. “You can get financing but it takes time. An investor with cash is the preferred purchaser and can get it at a better price.”

Tricon looks at the investment for income — it has a going in yield of 8% — and capital returns. Both are possible because the collapse of real estate prices has left plenty of margin for error.

“If you are looking to buy a property or vacation home, there is probably no better time to do it,” says Mr. Berman. “The dollar is high and the housing values are low.”

By Garry Marr

Taken from: http://business.financialpost.com/2012/11/10/no-better-time-to-buy-reits-now-invest-in-foreclosed-u-s-homes/
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REITs Still Offer Shelter from the Storm

Favorable industry fundamentals, strong balance sheets and a stabilizing US economy have combined to make real estate an attractive asset for investors, whose portfolios should continue to benefit for some time.

Publicly traded U.S. REITS, fully known as real estate investment trusts, — with combined market capitalization of more than $500 billion — have outperformed the broader stock-market , although investors would be wise to choose holdings based on sectors, geographic markets and company quality.

The FTSE NAREIT All REITs Index also outperformed the S&P 500 over the past three years, with nearly 28 percent in average annual returns, compared with roughly 14 percent for the S&P 500, as of July 31. Annual returns over five years averaged some 4.5 percent for the REIT index, versus 1 percent for the S&P 500.

Low interest rates, rising rents, strengthening demand and limited property supply bode well for REITs, which appeal to investors as relatively safe havens that represent real assets and provide solid dividend income. REITs typically invest in apartments, office buildings, hotels or other property types.

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“We like the growth and income story that REITs offer investors,” Philip J. Martin, Morningstar’s director of REIT research and strategy, said. Morningstar, though, believes REITs are trading at a 10-percent to 15-percent premium to fair value, with multifamily housing companies at a 20- percent to 25-percent premium, healthcare REITs at fair value and other segments somewhere in between.

“We’re being very selective in terms of business model, in terms of portfolio, in terms of location,” Martin said.

Improving Fundamentals

Balance sheet strength and dividend growth potential will be differentiating factors for REITs, which need to show they can weather economic uncertainty and dislocation and increase their dividends to outpace rising interest rates and inflation, he said.

Steve Shigekawa, Neuberger Berman managing director and real estate fund co-portfolio manager, said his firm’s outlook for investing in REITs remains favorable primarily because of improving fundamentals.

The firm believes REITs diversify holdings and enhance returns in investor portfolios, giving shareholders exposure to real estate.

In addition, REIT dividend yields are attractively valued now compared with fixed-income alternatives, such as U.S. Treasurys, one factor that may be driving stock performance, Shigekawa said. In 2010, REITs provided investors with $18 billion in dividends, according to the National Association of Real Estate Investment Trusts.

While macroeconomic and political uncertainty persist near term, “our long-term view is positive,” Shigekawa said, adding that REITs with strong balance sheets should weather market downturns.

It’s relatively easy to play the economic cycle with REITs, Morningstar’s Martin said, noting that investors in a defensive mode can lean to less cyclical sectors like healthcare REITs and shift into office, industrial or lodging as the economy improves.

Neuberger’s Shigekawa noted that economic growth and job creation are growing, albeit modestly, which appears to be driving demand for commercial real estate, including office buildings, apartments and industrial assets. Demand for commercial real estate versus the supply coming online is favorable for landlords, he said, explaining that supply across property types remains near historic lows.

Meanwhile, the low-interest rate environment has enabled REITs to lower borrowing costs and debt levels and improve balance sheets, which will allow them to grow through acquisitions or development, Shigekawa said.

Analysts and portfolio managers say dig into sector and company specifics when picking individual REIT stocks.

Residential Vs. Commercial

For investors who require multifamily housing in their portfolios, despite the premium valuation, Morningstar likes AvalonBay Communities [AVB 142.58 0.04 (+0.03%) ] , which Martin said benefits from owning properties in markets that lack affordable housing. Good supply-and-demand fundamentals are fueling multifamily housing, he said, explaining that many people now find it harder to finance a new-home purchase, or decide to rent out of concerns about eroding housing values or job security.

“However, at some point, purchasing a new home will become easier,” Martin added. Because an increase in home ownership in the next couple of years would weigh on the multifamily housing industry, it makes sense to own REITs in expensive home ownership markets like New York, San Francisco, southern California and Boston, he said.

Morningstar also likes Alexandria Real Estate Equities [ARE 74.54 0.10 (+0.13%) ] , which is trading at a 16-percent discount to fair value and operates in a segment with high barriers to entry. Alexandria owns, operates and develops space leased to pharmaceutical companies that need manufacturing and research-and-development facilities. It has room for attractive dividend growth, which will be important when interest rates start to rise and inflation occurs, Martin said.

Regional mall and apartment REITs, which are raising rents, are overweighted in Neuberger Berman’s portfolio. REITs tend to own a large share of the country’s best-performing regional malls, which have strong underlying fundamentals, according to Shigekawa.

Shigekawa also is trying to position the fund’s portfolio to take advantage of northern California’s technology industry-driven strong performance by investing in REITs that own office buildings, rental apartments and retail assets.

Simon Property Group [SPG 157.95 -0.80 (-0.5%) ], the largest publicly traded REIT and largest U.S. mall owner, is the Neuberger Berman Real Estate Fund’s largest holding.

“We believe that their management team is one of the best in the industry,” and the company has a strong balance sheet and one of the highest quality portfolios of regional malls and outlet centers, another segment where the firm sees good trends, Shigekawa said.

The Neuberger fund’s second-largest holding is American Tower [AMT 70.94 0.16 (+0.23%) ], which owns wireless and broadcast communications towers. Demand for tower space is growing rapidly because of requirements for smartphones and other wireless devices, Shigekawa said. The company has a strong management team, conservative balance sheet and attractive portfolio of assets, he said.

Taken from: http://www.cnbc.com/id/48862433

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