By Esther Fung
This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (May 16, 2018).
U.S. REITs have been underperformers for the past two years -- but as merger activity increases, some investors are giving them a look.
The FTSE Nareit All Equity REITs index produced a total return of 3.71% in March, compared with a 2.5% decline for the S&P 500 index over the same period. In April, the REIT index's total return of 0.52% outperformed the S&P 500's 0.4%.
Still, despite the recent uptick, the REIT index had a total return of negative 6.2% in the first four months of the year, versus the S&P 500's 0.4% decline.
"The tide is turning very slowly. It's not going to be a sea change," said Jonathan Woloshin, head of Americas equities and real estate at UBS Global Wealth Management's Chief Investment Office.
Commercial real-estate values have been appreciating for eight years, but expectations of a moderate slowdown rather than a hard landing are drawing some investors back, albeit cautiously, analysts said.
Within the different REIT sectors, some have continued to experience stable demand and healthy debt levels against the backdrop of a still-humming economy and job growth.
Going into 2018 there had been a view of decelerating real-estate fundamentals, but the first-quarter earnings came in line or slightly better than expectations, said Thomas Bohjalian, executive vice president at global portfolio manager Cohen & Steers Inc. Among malls and shopping-center REITs, "the bottom didn't fall out as quickly as some investors believed would occur," Mr. Bohjalian said, adding that Cohen & Steers has recently increased its position in some shopping-center REITs.
It is painful to see stock prices going down, but valuations are attractive, said Marc Halle, managing director at PGIM Real Estate, the real-estate investment unit of Prudential Financial Inc. and head of the Global Real Estate Securities business. "REITs are a good indicator of the direction of private market values. But they tend to overdo it on the way up and on the way down."
In particular, investors have taken a shine to the industrial and multifamily sectors, which are enjoying strong demand and tight supply.
In a recent report, Fitch Ratings pointed out that multifamily REITs with access to financing from government-sponsored enterprises Fannie Mae and Freddie Mac would put them on steadier footing than other REITs if the availability of mortgage capital is disrupted.
Another thing working in favor of REITs is a recent increase in merger-and-acquisition activity, which is fueling hopes, especially among impatient investors, of bigger gains via takeouts.
Private-equity giant Blackstone Group LP is buying industrial and office real-estate investment trust Gramercy Property Trust for $4.42 billion in cash, while Prologis Inc. made an $8.4 billion stock-for-stock offer for DCT Industrial Trust Inc., including debt. Both offered roughly a 15% premium.
Lodging REIT Pebblebrook Hotel Trust sweetened its stock-for-stock bid for LaSalle Hotel Properties twice and its final offer in late April implied a 31% premium to LaSalle's closing share price on March 27. LaSalle said it was reviewing the proposal.
"Takeout odds are REIT investors' favorite topics. It's the REIT version of TMZ," said Cedrik Lachance, Green Street Advisor's director of REIT research, referring to the celebrity gossip site. Investors often talk about personalities and mull over the age and career paths of CEOs and board members to speculate if these individuals are partial to a deal, he added.
To be sure, there is some skepticism about how much upside could be gained from any deal activity among retail REITs, especially after a revised offer price from Brookfield Property Group for GGP Inc. was deemed underwhelming among REIT investors. PGIM Real Estate said it reduced its holdings of mall REITs as their share prices gained ground on shareholder activism in the fourth quarter.
Green Street said it had a more tangible approach to address takeout odds based on prevailing share values. Of the 83 REITs it covers, nearly 40% had takeout odds of 10% or greater in the first quarter, up from about 20% of REITs in the previous quarter. Green Street also assigns an estimated takeout price to each REIT on the list, which might not be at a premium to their net asset values.
The top of the list includes a large portion of mall and strip-center REITs such as Taubman Centers Inc., Macerich Co., DDR Corp, Kimco Realty Corp, and Brixmor Property Group Inc. Green Street noted that the companies have been persistently trading at a discount to net asset value for the past two years, making them ripe for acquisition.
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