Two REITs for the Next Run

09/28/2009 12:00 pm EST

Focus: REITS

Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Roger S. Conrad, editor of the Utility Forecaster and associate editor of Personal Finance, says real estate investment trusts are on the mend, and he likes two of them.

From early 2000 through mid-2007, many popular REITs doubled in price and then doubled again. Then came the bear market, and the high-flyers gave up those gains and more amid an unprecedented number of dividend cuts.

Even the strongest REITs are grappling with tight credit, rising vacancies, and downward pressure on rents and property values. Meanwhile, speculation is swirling that a crushing wave of commercial property loan defaults is imminent.

[But] ironically, the tide has already started to turn for well-run REITs, [which] are finding the debt market much more inviting. Mall owner Simon Properties (NYSE: SPG) issued five-year bonds last month at a yield only 275 basis points above US Treasuries. That's in contrast with the 700 points the REIT had to pay on ten-year debt in March.

Falling borrowing spreads mean lower interest expense, easier refinancing, and greater ability to expand. That's a huge offset to high unemployment and other factors that are weakening commercial real estate in general. And REITs' access to equity is also on the mend; the sector raised $15 billion in the first seven months of 2009.

Washington REIT (NYSE: WRE) has long enjoyed Washington, DC's resilient economy. And over the past two years, it's proven its mettle with conservative financial and operating policies.

[But] even as the DC region is suffering, in management's words, the "suspended animation" of "real estate transactions of all stripes," the REIT posted second-quarter cash flow higher than last year's—rents rose, expenses were cut, and occupancy remained steady. It also repurchased $40.8 million of debt at just 91% of par value.

Despite a rebound this year, Washington REIT is still nearly 40% off its high; it's a buy up to $30. (It closed just above $28 Friday—Editor.)

Vornado Realty Trust's (NYSE: VNO) occupancy rates have dropped for its office properties in California, New York, and Washington, DC. That's depressed rents and induced management to pull in its horns, trimming expenses and selling noncore properties.

The REIT has also converted a portion of its quarterly distribution into stock for the past three quarters. And Vornado is unlikely to pay full cash dividends for some time. Management, however, is positioning for big gains as the economy regains strength, putting together a $1-billion fund to buy distressed properties.

The highest percentage play on office properties, Vornado is a Buy up to $60. (It closed above $63 Friday—Editor.)

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