Ralph Block, CEO of Alameda, Calif.-based asset management firm Phocas Financial, started investing in REITs during the Nixon administration. Since then, Block has honed his skills as one of the shrewder REIT observers, and in 2002 he penned a highly regarded book called “Investing In REITs.” The 63-year-old Block now advises institutions and high-net-worth investors on how to place their money into, among other vehicles, REIT securities. NREI spoke with Block in April about the underlying reasons for several public REITs going private.
NREI: In the first quarter, REIT privatizations totaled $9 billion. The $5.4 billion privatization of office REIT CarrAmerica, which now stands as the largest REIT privatization to date, was one highlight. Will we see more of these?
Block: We will see about six to 10 more of these deals before the year ends, but a lot depends on how REIT stocks trade — and they've been trading nicely. If REIT stocks keep increasing in anticipation of more buyouts, the higher prices will make it tougher to get these [privatization] deals done. You also have the 10-year Treasury yield finally responding to all of the pundits' forecasts, and it's moving up. If the 10-year Treasury yield goes above 5%, we'll see a slowdown in deals as financing costs go up.
NREI: Do these private deals, which have all involved premium takeout prices, suggest that REITs aren't overvalued after all?
Block: This is a legitimate question. Because net asset value is still an art rather than a science, there's a margin for error. The buyers have to figure that if their weighted average cost of capital to buy a company is maybe 7% in debt and equity, what kind of internal rate of return (IRR) are they going to get when they buy a REIT? They may say that it will pencil out because they'll get an IRR of 9% or 10%. I don't care who you are, but when you pay a cap rate of 5% or 6%, it will be awfully hard to get an IRR of 9% or 10%. It just doesn't work out that well.
NREI: Which REIT sectors do you favor now?
Block: : I still like hotels. The bigger, more expensive hotels are much harder to duplicate and replace compared with the limited-service hotels that can be built cheaply and quickly. That's why for my own portfolio, I like to own Host Marriott (HST), Sunstone Hotel Investors (SHO) and LaSalle Hotel Properties (LHO) because those kinds of properties will fare a lot better than the limited-service product.
I also like the apartment market. But the compression of cap rates has been more dramatic in the apartment sector [cap rates on apartment properties fell 50 basis points in 2005, reports Real Capital Analytics, ending the year at 6.1%], so if condo-mania dies in 2006 you'll have a lot of buyers unwilling to pay the extremely low cap rates for apartment properties. So much of the new residentialhas been channeled into the condo market. I'm sort of neutral on apartments when it comes to relative performance.
NREI: Do you have any general advice for REIT investors?
Block: I would advise the investor focused on absolute returns to come up with a realistic allocation to commercial real estate. Don't worry about all the cycles, because nobody can accurately forecast interest rates, booms and busts. Buy the quality names because at the end of the day, they are the ones that are a lot less likely to screw up.