As the century draws to a close, REITs find themselves at a crossroads. With acquisition opportunities drying up and stock prices remaining relatively flat - particularly in the retail sector - some REITs are having to reinvent themselves.
While no one is predicting the imminent demise of REITs, it's clear these public companies as a group are struggling to find new and creative ways to grow shareholder value. With the 1999 NAREIT Annual Convention in Los Angeles just around the corner, SCW interviewed Steven Wechsler, president and CEO of NAREIT, to discuss important issues affecting the industry. What follows is an edited transcript:
SCW: How would you compare the performance of retail REITs with other REIT sectors?
Wechsler: They have performed a little worse than the overall whole index, which is down 1.12% year-to-date through Aug. 31. It's fair to say the retail sector is not at the top of the heap, but they're certainly not near the bottom either. To give you some idea: Retail REITs were down 3.66% through Aug. 31; industrial/office was up 4.97%; residential (multifamily) was up 10.03%; and diversified was up 6.27%. Lodging/resorts was down 9.08%; health care was down 14.72%; mortgage-backed securities were down 20.13%; self-storage was down 2.18%; and specialty was down 21.43%. So retail has performed fairly well by comparison.
SCW: Does the retail sector face particular challenges not encountered by other REITs?
Wechsler: It obviously has unique challenges because it is tied to consumer purchasing. The growth of the Internet and Internet-based retailing has and will create some challenges for the retail real estate sector. Even though a very small percentage of retail sales have been Internet-based, the stocks have been affected. That clearly is in the air.
SCW: Do you consider retail REIT stocks to be undervalued?
Wechsler: That's for the market to determine.
SCW: How would you put the past year in historical context ?
Wechsler: The decade of the '90s has been one of very significant growth for REITs and publicly traded real estate. At the beginning of the decade, overall they owned a very small percentage of real estate in the country. Now they own about 10% of the marketplace. They had a growth rate of 140% from 1991-97. In 1998 we saw a correction, and we're still in that period. The market has been flat this year in terms of total return. Our expectation is that at some point down the road the market will revert to the historic norm of returns. This is premised on the very significant dividend yield paid by REITs, which today averages over 8%.
With respect to retail REITs, they have an equity market capitalization of more than $28 billion. In terms of real estate, that's over $50 billion of retail real estate owned by REITs and publicly traded real estate companies. Over time we'll continue to see it grow, but like everything else in life, there will be steps forward and steps back. We'll see companies here and there go private, and we'll see more go public. The move to securitization gained a firm hold in the '90s.
SCW: Are any of these issues greater than in past years?
Wechsler: There have been the seeds of some of these ideas, but this year they've taken on greater importance. Such as the innovative ways to access the capital pathway or other items that have been in the news: the use of joint ventures; privatization vs. taking companies public; and the phenomenon of stock buy-backs. Also, passage of the taxable REIT subsidiary, which is part of the overall tax bill.
SCW: What are the most important legislative issues facing REITs?
Wechsler: The most critical issue today, from NAREIT's perspective, is passage of the taxable REIT subsidiary legislation pending in the current tax law. Within that package is the REIT Modernization Act of 1999, which accomplishes several things to give REITs more flexibility in services they offer while still remaining real estate focused. It would allow REITs to operate taxable subsidiary services (such as valet or tenant-related services) that would help them remain competitive. The REITs would pay an income tax on income generated, along the lines of real estate owners on the private side and other publicly traded companies that are not REITs.
Also in the Modernization Act is conformance in payout rules, which takes the 95% distribution rule and reduces it to 90%, which is in conformance with mutual fund rules. (As of press time, the legislation had passed the House and Senate but had not been sent to President Clinton.)
The president has indicated he will veto the tax package. If this happens, Congress may put together a different package, and we're hopeful the Modernization Act, which received bipartisan support, would be included once again.
The other issue has to do with telecommunications and forced building access. The FCC has asked for comment on a new rule that would allow a few telecommunications companies to install their equipment in multi-tenant buildings for little or no cost. It's our viewpoint that the industry today is quite competitive and does not require federal intervention or regulation. We have commented with other groups in opposition to forced access.
SCW: What impact will global markets have on REITs?
Wechsler: Over time, we'll see increasing involvement by U.S.-based companies in real estate companies abroad. It's only to be expected in a world economy. Capital markets mirror these activities.
SCW: What will be the biggest issues at this year's convention?
Wechsler: We've patterned it after several thematic roads the industry is going down. The consumer gateway will look at how the real estate business is changing to tap into the consumer base. Another road is the electronic highway. We're going to take a look at implications for all kinds of real estate, starting with retail. And we always focus on the capital pathway, how REITs are accessing capital, whether we'll see more privatization, how important stock buy-backs are.
We'll touch upon the whole range of issues. We'll also look at branding, which has become an important part of the modern consumer-based economy. We'll look at the role of development and building tomorrow's cash flow as well as employee- and compensation-related issues. We'll explore demographics, from the changing investor base in the economy as well as users of real estate.
SCW: Is there anything you'd like to add?
Wechsler: It's important to note that one of the key issues over the past year and a half has been the apparent disconnect between the performance of REITs and publicly traded real estate as companies and their performance as stocks. It's been a fascinating divergence. For the past year and a half, we've had the vast majority, including the retail sector, perform quite admirably in terms of growing profits, and yet the stocks have declined since early 1998.
And so today you have many, many companies arguably trading below net asset value in a reasonably efficient, functioning marketplace. If companies continue to perform along these lines, one would expect the stock to reflect the underlying performance of companies. Time will tell.