Traditionally seen as a relatively safe haven from the vagaries of the stock market, shares of real estate investment trusts have been on a wild ride over the past year. With a fourfold increase in volatility, REIT stocks have been whipsawing as much as those in the Nasdaq composite index and the Dow Jones industrial average, notes Anatole Pevnev, founder of REITCafe.com, a research and analytics Web site that focuses on the sector.
The inclusion of REITs in the Standard & Poor’s 500 index several years ago, which attracted a wider set of investors, helps explain the shift, says Pevnev, as does the broad market turmoil of late. “Investors came to REITs because of the perceived safety,” Pevnev notes. “But now more investors trade in these stocks, and there will be more volatility as they keep reweighting their portfolios.”
REIT stock prices dropped by 15.7 percent in 2007, according to research from Cantor Fitzgerald. That compares with a 5.5 percent rise in the S&P. Through February 26 the Morgan Stanley REIT index was up 0.04 percent, while the S&P 500 was off 5.93 percent. Philip Martin, an analyst at Cantor Fitzgerald, says he believes that REIT stocks are now trading at a discount of 15 percent to net asset values.
REITCafe last year rolled out an index to track the volatility of the sector. It is calculated using the benchmark Morgan Stanley REIT index and follows all changes in REIT stock prices over the previous 20 trading days. As its baseline the index uses the average of REIT stock price changes from 1995 through 2006. It started 2007 at 95 and hit a new peak of 351.38 in late December. That month REITs saw the then-highest-ever level of volatility, when prices dropped by 6 percent one day only to rise by 4 percent the next.
In all, the index saw four major surges in volatility in 2007. “As we came through 2007, we saw day-to-day bounces in REIT shares, which is not something we’ve traditionally seen,” Pevnev says. He adds that after Blackstone Group completed its February 2007 acquisition of Equity Office Properties Trust, the biggest REIT in the S&P 500 index, volatility jumped dramatically, as shareowners looked to reinvest their gains in other REITs.
“For a number of reasons, the years leading up to 2006 had lower than average volatility. This was because of a Goldilocks scenario where investors were generally in agreement on the economy, interest rates and expectations for real estate,” says Todd Briddell, chief investment officer at Plymouth Meeting, Pennsylvania–based Urdang, which manages real estate securities and direct investment funds. “However, leading up to and ending with the Equity Office–Blackstone transaction, a price war was waged between fundamentals-based real estate investors and the highly-levered private equity folks, who were looking to arbitrage unsustainably low cap rates in the private real estate market by taking higher-cap-rate public REITs private. After that, prices rose to a point where the arbitrage was baked out, and the bid premium on REITs disappeared.”
Capitalization rates — a common measure of commercial real estate values — are calculated by dividing a property’s net operating income by its actual or estimated value. “Today’s excess volatility represents the battle between real estate investors who think REITs have found a bottom and generalists who are indiscriminately slashing exposure to both commercial and residential real estate,” says Briddell.
The sector’s growth in volatility continued into this year, with the Morgan Stanley index rising to a record 445.08 on January 30. “REITs have been consistently more volatile over the past 12 months than the Dow Jones industrial index, the Nasdaq composite index or the S&P 500 index,” says Pevnev.
Still, the sector’s correlation to the broader stock markets is starting to level off. In late January the correlation dropped below 0.7, according to data from REITCafe. As of February 1 the Morgan Stanley REIT index had a correlation of 0.714 with the Dow Jones and 0.688 with the Nasdaq.
In the coming year REIT stocks may benefit from healthy fundamentals for the sector, which operates off of a different base than the residential arena’s. “Poor REIT share price performance is due primarily to credit market dislocation, not weak commercial real estate and equity REIT fundamentals,” Cantor Fitzgerald’s Martin notes.
