Where REITs Gather

By Wilkerson, Bret | Mortgage Banking, July 1998 | Go to article overview

Where REITs Gather


Wilkerson, Bret, Mortgage Banking


A look at where REITs have concentrated their investments reveals some interesting findings. The apartment sector has the greatest percentage ownership by REITs. What does REIT market concentration mean for other players in the commercial real estate markets?

How much of the Dallas office market is in publicly traded hands? Can one get exposure to the Milwaukee warehouse market through the public markets? Where are the REITs (real estate investment trusts) concentrating new investment opportunities?

Investors in equity real estate, via either the public or the private markets, must be knowledgeable about both the concentration of REIT investments and the flow of REIT capital. This knowledge is needed to make intelligent choices about how to participate in a particular market cycle and how to develop sharp strategies for creating and disposing of private equity in the context of a very active REIT market. With the recent increased securitization of real estate, greater (but not yet great) information is available to investors.

Of the four quadrants of real estate investing (public equity, private equity, public debt and private debt), public equity is the smallest. Today, the total market capitalization of the quadrant is roughly half the size of public debt, the next smallest.

Private investment continues to dominate all equity investment in real estate. However, the rate of growth of public real estate equity capital during the past five years has been tremendous, capturing much of the attention of today's real estate investors.

Recent REIT expansion has been ad hoc and grown at an unsustainable rate. The sector has grown for growth's sake, with little thought given to real estate cycles or the diversity of the portfolio.

As an emerging investment market in a mature industry, REITs provide an opportunity for intelligent investors to make informed decisions and make a significant amount of money. This was done fairly easily from 1995 to 1997, with tremendous industrywide annual returns. However, thus far in 1998, REIT performance has been disappointing to those who have come to expect 20 percent total returns. Is it possible that the underlying real estate performance now matters to investors in public real estate?

This article will demonstrate where the REITs have focused their marginal investment dollars during the past five years. It will also review the markets in which REITs had an early impact in order to more completely understand the implications of the growth of REIT ownership in individual markets.

While it is important to note trends in real estate cycles at the national level, it is becoming increasingly apparent to the investment community that individual markets perform very differently from one another. For these reasons, we will study trends in REIT investment at both the national and local levels.

Methodology and calculation of exposures

The REIT research done at Property & Portfolio Research (PPR) concentrates on the real estate markets in which REIT properties are located and on the fundamentals and performance of those markets. We forecast individual REITs' performance based on the theory that markets (and the combination of markets) matter. By first estimating each REIT's exposure to individual markets and property types and then applying our forecasts for each market, we discern if a REIT is fighting an uphill battle to increase funds from operations (FFO), or if the public market should be rewarding growth that results from being in the right place and combination of places at the right time.

PPR uses its proprietary historical and forecast time series of market performance, which are driven by the interaction among supply, demand and the influence of capital markets. We model net operating income and capital value separately, so we are able to estimate the value of real estate in each of 60 cities and four property types over time and into the forecast period. …

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