REITs Continue To Rally, But Can This Rally Be Sustained?

REITs have staged a nice comeback since March. Overall, equity REITs are up about 38% so far in the 2nd quarter. Year-to-date, REITS are still down about 6% and 48% over the past year. All sectors are up in the 2nd quarter, with the highest gains in lodging, regional malls, and shopping centers.

So what is driving the rally?

1) The market is up. After a rash of negative news, investors are starting to believe that the banking crisis could be nearing end - or at least is near the beginning of the end.

2) REIT share prices were beaten down to unrealistic levels in the midst of the credit crunch - well below even conservative estimates of NAV [net asset value]. Even companies with little or no near-term maturing debt were swept up in the selloff.

3) Over the past year, REITs have been proactively addressing balance sheet concerns and trying to de-lever. Through asset sales, equity issuance and even dividend cuts most REITs are raising cash any way they can to pay down debt. In addition, most companies have drastically scaled back or frozen new development starts. Investors have generally reacted positively to these steps, even though many secondary offerings are dilutive to current shareholders.

Can this rally be sustained?

From initial 1Q results, it is clear that fundamentals are declining in all property types. Job losses and consumer spending trends will not get any better in 2009 and will probably get worse. This will continue to weigh on operations, earnings and, in turn, share prices.

We expect a choppy trading environment going forward. Buy companies with stable dividends and conservative leverage. Two names we like are Mid-America (MAA) in apartments and Public Storage (PSA). Both companies have no material near-term debt rollovers and safe payouts.

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