REITS: Separating News From Noise

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Interest rates remain relatively low, creating an army of investors who are searching for reliable income streams. Real Estate Investment Trusts (REITs), several of which have a large presence on eastern Long Island, have often delivered a healthy yield and very often a bit of share price appreciation as well. Lately, however, even REITs with strong balance sheets and enviable business lines have seen a decline in their share price. But there may be a silver lining because as share prices drop, yields tend to increase.

“Rising interest rates can hurt REITs because they make it more expensive to borrow money,” said Southampton-based financial adviser Rocco Carriero during a recent interview. “While results have largely been positive for mall REITs overall, they’ve nevertheless been hurt by what will be higher borrowing costs and a slowdown in consumer spending.”

Good shopping mall REIT operators have to be judged by other areas however. A key component is occupancy. The REITs covered here, Tanger Outlet Centers (SKT), KIMCO Realty (KIM) and Acadia Realty Trust (AKR) each has a Long Island presence, as well as high occupancy rates and reliable tenants which help relieve them of some of the blow that may be caused by slowing sales due to higher interest rates and a sluggish economy.

The reason for the interest-rate uptick is that the 10-year Treasury yield, the standard for permanent, fixed-rate commercial financing, has been rising. This means that the cost of borrowing money has also increased. The 10-year Treasury yield has climbed to 2.9 percent from 1.63 percent on May 2, its low for the year, while the Bloomberg mall REIT index has fallen 18 percent since May 21, its high for 2013.

But now may not be the time to hit the sell button on retail REIT investments, according to some.

Brad Case, senior vice president for research and industry information at the National Association of Real Estate Investment Trusts offered an analysis of the REIT market’s performance recently.

“REITs don’t do badly when interest rates go up. That’s because interest rates tend to go up when the economy is strengthening,” he wrote. “That strengthens the demand for commercial real estate and the earnings from owning commercial real estate. REIT investors generally do well when the economy is strengthening, and that is going to continue. And they do well when interest rates go up, because that goes along with a strengthening economy. That’s the real story that investors are going to see over the next several months.”

Standard & Poor’s REIT analyst Robert McMillan offered a similar outlook.

“Although challenges remain and rising interest rates may sap enthusiasm from shares in the near term we think increasing absorption of retail space should present retail landlords with pricing power. We expect consumer spending and retail sales to increase, prompting a slowdown in store closings. Most REITs have long-term leases with customers that feature automatic rent increases, insulating them from economic fluctuations.”

Shares of Tanger Outlet Centers, with a large presence in Riverhead and Deer Park, still yield approximately 2.5 percent but share price has dropped from $37.50 in May to about $31.75 in mid-September.

Tanger, widely credited for developing the outlet center model, is facing competition from other companies using the same formula. Nevertheless, Tanger has low leverage, limited balance sheet risk, growth opportunities and reliable Net Operating Income. It recently announced a partnership with Simon Property Group, Inc. (SPG) for two development properties. This move helps alleviate some of the competitive threat it is facing.

The 50-50 joint venture with SPG calls for the construction of Charlotte Premium Outlets in North Carolina. The first phase of the planned 400,000 square-foot center will open in summer 2014.

Deer Park-based Kimco Realty Corporation’s shares are paying a quarterly dividend of 4.1 percent. Shares have fallen approximately 5 percent this year.

Kimco has an interest in nearly 2,000 properties, specializing in shopping center acquisitions, development and management. In business for over 45 years, it owns and operates the nation’s largest portfolio of neighborhood and community shopping centers in 45 states, Canada, Mexico, Puerto Rico and South America. Locally, it owns and operates properties in Bridgehampton and Riverhead. Most notably it operates Bridgehampton Commons and East End Commons in Riverhead, as well as other Long Island-based operations.

Kimco is focusing on owning and operating strategic retail assets through investments in North America and selling non-strategic retail and non-retail assets. It recently sold to an affiliate of Starwood Capital Group its InTown Suites Company and related real estate assets for $735 million, including $609 million of existing mortgage debt. Upon closing, Kimco realized approximately $103 million in proceeds for property with a book value of approximately $83 million, and Wall St. has noticed.

Zacks Investment Research recently upgraded Kimco to a “buy.” The upgrade came after Kimco’s solid second-quarter 2013 results and reliable operating fundamentals. Kimco posted positive same-property Net Operating Income increases for 13 consecutive quarters, helping it to regularly get smooth access to capital. Showing confidence in a rocky market, Kimco also recently raised its share guidance for the second time in one year.

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