Real Estate Forum - October 2013

most of the adjustment phase, though they admit there will be more adjustments as the economy shifts from one that’s weak and needs monetary stimulus to one on stronger footing with no stimulus requirements.

“REITs are sensitive to economic pressure,” Marcus says. “When there is strong economic growth, REITs are favorable investments. When the economy is at a standstill, REITs tend to be soft.” There’s also more competition among REITs as new trusts continue forming. With some M&A madness going on, the industry is seeing consolidation even as upstart REITs continue coming to market.

At the end of the day, it boils down to fundamentals that work to defy market challenges. Terrell Gates, CEO and founder of Virtus Realty Capital, an Austin-based private equity fund, is concerned about some of the business models he sees emerging in the evolution of REITs, particularly raising capital from individual investors via brokers and dealers and RIAs touting the private to public arbitrage and ensuing liquidity. He says the exit strategy is risky.

“For REITs to win long-term, they need to buy solid assets within
their long-term strategy and focus on increasing NOI of those
assets over the long haul,” Gates says. “That will generally allow a
REIT to ride out the short-term swings of the stock and public
REIT markets while driving long-term shareholder value.”
Gehl also sees the REIT story taking an unexpected turn with
private REITs, which have emerged on the scene in a big way and
are compressing cap rates. But he questions the durability of their
dividends, and finds it troublesome that there are no institutional
holders of private REIT stocks. He says, “We feel that the average
retail investor looking for retirement income and exposure to real
estate will continue to allocate a portion of their retirement nest
egg into REIT stocks.”

WHAT LIES AHEAD?

REITs have made a strong comeback overall this year. Fed Chairman Ben Bernanke announced the Federal Open Market Committee decided not to taper QE, at least not in the near term. On Capitol Hill, the focus is on the debt ceiling and funding Obamacare. Marcus says this will make the market more volatile.

“During volatile times, REITs are more favorable because of
the dividend payouts,” he says. “REITs are like investing in gold—
they are either hot or not. Right now, they’re hot. But next year,
once the FOMC starts unwinding QE, they’ll be less in favor.
Since they’re classified as interest-rate sensitive, they’ll be less
interesting.”
From his perspective, Stapp sees no reason for a change
unless public policy changes. In fact, he says there are interest-
ing ways to use REITs that have not yet been fully explored. Real
estate is much more than just a financial vessel for generating
returns, he explains, it’s also the engineered, fixed capital of a
community. “Using REITs, it’s possible for residents to focus on
owning the buildings in their own communities,” he says. “One
can argue the wisdom of that, but it would allow local assets to
be owned by members of a community who want to invest
locally. REITs can stay positioned to deal with trends because of
their staying power.”
The retail sector offers some proof to back up Stapp. In the
industry, the economy and changing demographics have caused
adjustments to how and where investors buy—and what they
want from the experience. He says REITs that own key proper-
ties are better able to make adjustments and keep property from
becoming socially obsolete through further investment and
repositioning.

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