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Initial warnings


Photo: Real estate stocks brought significant gains in 2006. The “golden times”, however, seem to be over. Prices have been falling since the beginning of 2007.

The recent turbulences should give Martin Allen of Morgan Stanley silent gratification. The analyst already warned of more engagements in real estate stocks in the beginning of 2006 and pointed out that “most stocks were already traded clearly over their net asset value.” Other industry experts secretly agreed with him, but hardly anyone admitted this to the public. According to an analyst of a large German bank behind closed doors, “Martin Allen made daring presumptions similar to Robert Shiller at the end of the 1990s”. The US economist already warned about the Internet bubble in 1999. His predictions of a crash came true a year later.

Had investors followed Martin Allen’s advice he gave at the beginning of last year, they would have had to do without significant earnings. Analysts of the Dutch bank Kempen & Co calculated that real estate stocks across Europe in 2006 gave their investors a total average return of 41 percent from stock growth and dividends. In the USA, REITs made profits of roughly 35 percent last year. In Asia, the total return of the real estate stock reached an average of over 30 percent.

Overheating phases in the stock market can last long, says Anthony Gallea, Managing Director at Smith Barney. “Anticyclics will have to accept that they will be in the wrong for a while.”

Price hikes are hardly expected

However, the gains of the past year have meanwhile led to a consensus among experts about the statements of Martin Allen. The investment bank Lehman Brothers recently rated the British REITs from “positive” to “neutral”, and were sceptical about the publicly traded real estate stocks in the rest of Europe. Their analysts Mike Prew and Chet Riley warned about the hope for more increasing quotations: “There is no sense in pushing up the target prices more and more like Sisyphus.”

Sceptics out there are having weighty debates: In France, real estate stocks and REITs are being traded with a surplus of roughly 40 percent on the NAV (Net Asset Value), with 30 percent in the Netherlands and many German stocks. Great Britain still reached 20 percent after the most recent price declines.

Traditionally, real estate stocks were mostly traded under their NAV. The analysts of the Dutch bank Kempen & Co expect an average total return of only four percent for this year with the real estate stocks in Euro values. After this forecast, price increases are out of the question. Most returns will come solely from dividends.

The cradle of the real estate stock boom

The cradle of the real estate stock boom is the stock market crash of 2001. As the Internet stocks crashed, investors in the USA, the Netherlands, Canada, Australia and Japan rediscovered the so-called boring REITS as “sure moneymaking machines”.

Because the real estate trusts do not tax their earnings, but have to give almost all of them to stockholders, the dividend payments were voluptuous. According to the statistics of their industry association, the National Association of Real Estate Investment Trusts (NAREIT), the average dividends of US REITs were 7.38 percent in 2001.

As Federal Reserve President Alan Greenspan lowered the US interest rates to only one percent, the stocks became more attractive. Institutional investors, hedge and private equity funds could now borrow a lot of money cheaply to buy REIT stocks. The dividends were high enough to not just pay for the loans, but also to make returns of more than 20 percent on capital. The fact that private investors jumped on board and the stocks were pushed up even more was icing on the cake for initial investors. This trend soon spread to real estate stocks in the countries still without REITs, but where investors saw an opportunity to introduce REITs through lobbying: in France, where REITs made their debut in 2004, Great Britain, Germany, Italy and Spain.

Price losses for US REITs

Meanwhile, this strategy no longer works. The reserve banks have raised their interest rates again, which has curbed the dividends from high stock rates of the real estate stocks. Currently, the dividend earnings of the US REITs according to NAREIT calculations are only 4.08 percent. Safe US bonds with only a two-year period are earning a more attractive 4.75 percent.

The executive managers of the US REITs expect sharp stock losses in the coming months. According to a Lehman Brothers study, the volume of insider sales in the first quarter has increased by 23 percent. “Roughly 70 percent of all REIT stocks sold from January to the end of March 2007 are from insiders”, claimed analyst David Harris. The selling wave can also be seen in the North American index of Global Property Research: since the beginning of the year the below-zero figures have grown to over ten percent.

Source: EPRA; Date: March 30, 2007