Friday Letter REIT 'em and weep

With the credit crunch showing no signs of easing, REITs globally are looking increasingly stressed. For private equity real estate firms, their plight might produce great investment opportunities. 

Private equity real estate funds are on course to raise more capital in 2008 than ever before. Yet skeptics have questioned just how the industry is going to put all the money to work, particularly the portion targeted at distressed situations. There have been fears that demand would simply outstrip supply. But now a new type of target appears to be materialising: real estate investment trusts.

After overcoming a torrid year in 2007, the REITs industry thought it had turned the proverbial corner after posting solid gains in the spring of this year. After the first five months of 2008, the National Association of Real Estate Investment Trusts (NAREIT) was keen to highlight the fact that its key benchmark, the FTSE NAREIT All REIT Index, was up 6.46 percent compared to the Dow Jones Industrials (down 4.72 percent) and the S&P 500 (down 3.80 percent).

But despite this apparent recovery, it now appears the worst may yet be to come for REITs. June was an especially “tough” month globally, a spokesman for NAREIT told PERE, with total returns of the All REIT index down 11.25 percent. Not since April 2004 has the industry seen such a decline in monthly returns. (The last time before that was October 1987.) Yet, as the cliché goes, where there is crisis there is also opportunity – not least for private equity investors.

As a result of declining stock prices, some REITs are now unveiling “strategic reviews” with plans to sell off some or all of their real estate assets. This week American Land Lease, a Florida-based senior housing REIT, was the latest to succumb to the market turbulence, admitting it was considering selling “some or all” of its 7,500 senior housing sites in the US. The firm followed moves last week by Canadian REIT Huntingdon Real Estate Investment Trust, which put a ‘for sale’ sign on its 5.4-million-square-foot portfolio of office, retail and industrial buildings. The Western Canada-focused REIT, which owns 79 buildings and parking lots, is worth about C$140 million ($137 million; €88 million) and owes about $330 million of mortgage debt.

It is worth noting that REITS in North America are the ones experiencing the least trouble. REITs in Japan are on average trading at a 35 percent discount to the value of property on their books, with Tokyo's REIT index having lost nearly half its value since it peaked last May. California and Japan-based Dalton Investments is already raising a $450 million fund to capitalize on the trend. In addition, Australian Listed Property Trusts and UK REITs are also experiencing continued trouble.

To be sure: REITs which announced a “strategic review” have stressed they ultimately may not sell any assets if a deal runs against the long-term interest of shareholders. However, private equity real estate firms with capital to deploy are sizing up the opportunities in front of them. And those opportunities are looking increasingly attractive. As one professional told PERE: “Things are getting more exciting by the day.”