REIT’S
Array of Niche REITs Survive, Even Thrive in Unforgiving Real Estate Market
REITs Dealing in Life Science, Data Center, Student Housing and Medical Office Assets Mostly Fare Better Than Market Generalists
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The outlook among publicly traded commercial real estate REITs following the second-quarter results was decidedly subdued. However, there were several notable bright spots among those focused on a handful of the tightest office markets, and REITs specializing in property niches like life science flex buildings and medical offices, self-storage, data centers and student housing, many of which appear to outperforming the market.
The strength of the niches reflects a potpourri of varying economic and demographic factors, including an aging Baby Boomer population, an undersupply of on- and off-campus housing for college students based on projections of the number of teenagers turning age 18, growing investment in biotechnology and medical research, growth and consolidation among Internet and telecommunications companies, and dislocation of former homeowners in the troubled single-family housing market.
The more mainstream property sectors continue to experience turbulence despite continued strong leasing and vacancy fundamentals in many areas. Most real estate investment trusts downsized their growth estimates for the second half of 2008 and ’09 in the face of the credit crunch and general economic malaise.
REIT executives are falling back on basic strategies that have steered them through previous real estate downturns. Many singled out their financial and leasing teams for praise during second-quarter conference calls as they focused on keeping debt under control and holding down vacancies by negotiating long-term leases in 2007 — while working to renew expiring leases early in a period of generally flat rent growth.
“There are four constants that are essential for a company during a difficult period, and they all start with the letter L: low leverage, low payout ratios, lots of liquidity, and finally, level-headed talent,” said Milt Cooper, CEO of retail REIT Kimco Realty Corp. (NYSE: KIM).
“Typically in a slowing economy we have a number of tenants usually on the office side approach us about terminating their leases early to downsize their space and reduce overhead costs. So far this year we have not seen that happen,” said Dennis Oklak, chairman and CEO of office and industrial REIT Duke Realty Corp. (NYSE: DRE) “We believe this is a positive sign because when the economy turns around — which it eventually will — the need for space should accelerate quickly.”
Over the last three weeks,CoStar Advisor listened in on most of the conference calls for more than four dozen REITs in the office, industrial, multifamily, mixed and specialty spaces. Executives with players specializing in the niches, along with some of the high barrier-to-entry office markets on the coasts, were among the most bullish on prospects for the next 18 months.
Self Storage
The self-storage sector was the strongest REIT segment in the first half, with returns up more than 12%, according the National Association of Real Estate Investment Trusts (NAREIT). Supply-and-demand fundamentals are driven by a simple fact: people who are the victims of foreclosure need a place to put their stuff, making the sector one of the most defensive investor plays among REITs.
However, the surge in the popularity of self-storage also means that the stocks are no longer as cheap as they used to be relative to their asset value. Some of the bigger players, including Public Storage Inc. (NYSE: PSA) and U-Store-It (NYSE: YSI), have been dragged down by the general economic malaise in Florida.
Hurricanes Katrina, Rita and others “filled everything up” in 2005 — virtually all of the Florida storage space was full with rent hikes of up to 25%, said Dean Jernigan, president/CEO of U-Store-It.
“It lulled us into a sense of false security, I think. When those people started moving out, it uncovered what was underneath and that is perhaps management teams that had grown to accept something less than perfect, they weren’t as energized as before. I think another term is bad, dumb and happy.”
However, the third quarter has started off in promising fashion, with a newly-formed joint venture of Sovran Self Storage (NYSE: SSS) and Chicago-based real estate management firm Heitman pulling off one of the largest self-storage property transactions ever last week, acquiring a $144 million portfolio from San Antonio-based Hendry Investments. The 1.62 million-square-foot portfolio consists of 21 Lock-N-Key Mini-Storage locations in five states. The properties are 84% occupied and are in the Houston, Dallas, San Antonio, Tampa, Columbus, Denver, and Louisville markets.
Life Science
Alexandria Real Estate Equities (NYSE: ARE), the first REIT to exclusively focus on space for pharmaceutical, biotechnology and life science product/service companies, is benefiting from the perception among investors that the asset class carries a higher risk. The result: an effective barrier to entry that helps specialized players, like ARE, armed with the industry knowledge and track record to effectively underwrite credit tenants, be able to acquire and develop properties at attractive initial yields, unlike many other development-centered REITs. Analysts expect Alexandria will continue to reap above-average earnings by tapping income from its extensive development pipeline.
“We concentrate on the highest quality and most flexible world-class lab space. We’ve stuck to our knitting with highly flexible and generic space and we’ve generally try to avoid highly specific tenant facilities and those that are verey costly manufacturing facilities,” said CEO Joel Marcus. “Recently, other landlords have stumbled when they sought these kinds of facilities or transactions.”
Marcus said ARE is “in great shape for the remainder of the year,” reporting strong first-half leasing in the San Diego market and other life science clusters around the country. Rental rates are up more than 19% for renewed and released space and two-thirds of its expected lease rollovers for the year are either completed or committed. The REIT’s average occupancy is at 95% — even higher in the especially tight San Francisco, Massachusetts and Seattle markets.
“The life science industry has a positive long-term factor that supports the continuing need for research , which drives the need for our property, not just today but also in the future, said Alan Gold, chairman, president and CEO of BioMed Realty Trust, Inc. (NYSE: BMR). “Our long-term, triple-net leased structures provide us with relatively stable, steady and predictable cash flow stream.
On the development front, “we are hitting major milestones across our entire program,”including the completion of core-and-skeleton at Towne Center Drive in San Diego, where Illumina will expand their presence on its San Diego campus to 193,000 square feet, he said.
BioMed leased more than 327,000 square feet in the quarter, highlight by its 144,000-square-foot lease with DayStar Technologies at the Pacific Research Center in San Diego. BioMed was also able to deliver more than 241,000 square feet during the second quarter to four tenants at the Center for Life Science in Boston, a 703,000-square-foot research facility.
Data Centers
Since the bursting of the Internet bubble early in the decade, technology-related real estate has been an underserved asset class. REITs like Digital Realty Trust (NYSE: DLR) and DuPont Fabros Technology, Inc. (NYSE: DFT) have been among the first focused exclusively on the data center space, where there are few competitors due to the expensive development costs.
For example, extensively improved space owned by Digital Realty can cost between $700 and $1,000 per square foot to build out. DLR has 2 million square feet in its redevelopment pipeline at very favorable yields that are roughly twice those of traditional office space, resulting in above-average earning growth project for the next three years, according to Citi’s REIT research group.
Hossein Fateh, president and CEO of DuPont Fabros Technology, Inc. (NYSE: DFT), said the data center specialist’s portfolio was just under 94% occupied in the second quarter, up 600 basis points from the previous quarter. While tenants are taking longer to sign leases, “we have several letters of intent executed and remain bullish on the existing traffic and prospective customer interest in all our facilities,” Fatah said.
“The supply and demand parameters are still in our favor that remains significant barriers to entry in the wholesale data center business,” said Hossein Fateh, president and CEO of DuPont Fabros Technology, Inc. (NYSE: DFT). “We are working very hard to execute leases and remain confident in our ability to do so. We have a conservative capital structure with low leverage and we are in the process of obtaining financing to fund our additional development projects.”
Construction of the first phase of DuPont Fabros’ ACC5 center in Ashburn, VA continues on schedule for completion at the end of first quarter of 2009, and the company broke ground in the first quarter on the first phase of a center in Piscataway, NJ, a project set for completion in third-quarter 2009. DFR started demolition at a development site in Santa Clara, CA, earlier this month and plans to begin construction of a facility scheduled for delivery in the fourth quarter of 2009.
Student Housing
Housing on or near college campuses is enjoying strong demographics that provide more protection from economic cycles than traditional apartment companies, industry analysts say. Driving the demand is the more than 4 million Americans in each of the next 12 years and 400,000 Canadians each year that will turn age 18 until 2019, according to a recent report published by Urban Land Institute.
Investors have taken note, and companies like American Campus Communities Inc. (NYSE: ACC) have built a strong platform based on the development and acquisition of those assets.
“We are very pleased with the continued success in all areas of our business,” said ACC CEO Bill Bayless. “We believe that our core performance this quarter coupled with our lease-up progress and rental rate growth for the upcoming academic year demonstrate the quality of our portfolio and our ability to execute on our business plan.”
“The other companies that have student housing expertise are not well capitalized and have to bring someone else’s money to the table,” Bayless said. “It is a segment that does have good barriers to entry, and that is one of the reasons we are most excited about it.”
