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Slightly Smaller Giants

Here’s the logic behind REITs, as far as I understand them: while conforming to the government’s regulations for pass-through entities, investors pool massive amounts of capital to acquire and profit from large amounts of real estate, controlling portfolios well beyond the reach of smaller investment vehicles.

Or, to put it even more simply, the logic behind REITs is this: they’re big.

Holding fast to the idea that a REIT’s success is in pretty much direct proportion to its size, I was surprised to read this report on REITs’ activity in the recently completed first quarter. As the Wall Street Journal explains, the big winners in terms of revenue (which is generally how “winning” is decided in such things) were not the usual REIT behemoths (Simon Property Group (SPG), General Growth Properties (GGP) , etc.). Rather, the Dow Jones All-REIT Index shows the highest returns came from the “smaller” REITs: 

  • Pennsylvania REIT (PEI)
  • Sabra Health Care (SBRA)
  • iStar Financial (SFI)
  • CoreSite Realty (COR)
  • Invesco Mortgage Capital (IVR) (see graphic at top for all the numbers)

Let’s look at Pennsylvania REIT. Although I don’t have any up-to-date numbers, the most recent reports I found on total assets showed the REIT had over $3 billion in total assets in 2009. That’s a tiny sum (I’m saying this without any attempt at irony) when you compare it to retail Goliath Simon Property Group‘s assets from the same time, which are over $20 billion.

Despite the fact that the smaller REIT had a brutal 2011, and scared off potential investors with its high leverage and under-performing retail assets, the REIT was…

the top-performing REIT in the Dow Jones index for the first quarter with a 48% total return. That is a turnaround from last year, when Pennsylvania REIT was one of the worst performers, posting a return of negative 24%. (WSJ)

I can understand investors shying away from anything with a more than modest amount of leverage. 2011, after all, was the year we saw the collapse of a financial giant associated with a certain former New Jersey Governor because of such high leveraging.

Yet the Pennsylvania-based shopping mall investor is starting 2012 with a bang, as are other smaller REITs, demonstrating that size alone is not the only factor for success. There are a lot of more whimsical fundamentals which also impact a REIT’s success: changing returns/attitudes in the retail sector (for retail REITs), fluctuating travel and luxury trends (hospitality), and improving or declining attitudes toward residential construction (for multifamily or timber REITs, depending which way it goes). In the end, it seems, some of the biggest fundamentals are a matter of luck–or excellent foresight.

#CRE #finance

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