Shopping for REIT Bargains

 | Dec 13, 2011 | 1:30 PM EST  | Comments
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Stock quotes in this article:

krg

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cdr

I make it a point as I go through my day to talk to as many people as possible. I can learn more about the economy and people's perceptions about the world by hanging out in the local diner or by sharing a cocktail while watching a game at the local pub than I can from reading many of the charts and graphs released by economists. I find that many economists have not been outside of Manhattan of Washington, D.C. in decades and think their computer screens really reflect on the world. Quite often, they do not accurately reflect the economic reality of the world we live in. It may seem like I spend the weekend goofing off while having breakfast at Mike's Diner followed by watching the Ravens whip the Colts at Two Rivers Steakhouse, but in reality, I was conducting in-depth research.

The group I watched the game with this past weekend included a local commercial real-estate broker whose business covers most of the Washington, D.C.-Baltimore area. He confirmed for me that while demand in D.C. is very strong outside the beltway, conditions remain relatively weak. I mentioned that, according to Standard and Poor's, the hardest hit sectors among equity securities were hotels, industrial and retail properties. For the price of a pint, my new friend basically confirmed the data for me.

A lot of distressed commercial properties are still on the market and there will be more to come as the "extend and pretend" loans of the last few years once again come due for payment. For these three segments of the property marketplace, demand for these properties is spotty and vulturistic in nature.

As a fellow with the tendencies of a vulture, these are naturally the areas in which I am shopping for bargains in the real estate investment trust (REIT) sector. I have two shopping center REITs in my portfolio that I think have extraordinary upside over the next five to 10 years. Looking to today's retail sales report, it is still far from a robust retail environment. Plus, my mall spies report that there are still vacancies and "going out of business" signs in most of the area malls. At some point in the future, the economy will begin to recover, consumer confidence will firm up and retail properties will see rising occupancy rates as well as rental rates. When that happens, the properties we are buying today at a steep discount via the REIT sector should rise sharply in value.

Cedar Realty (CDR) is one of my favorites right now. This shopping-center REIT has locations with more than 13 million square feet of space. Plus, 77% of their centers are anchored by grocery stores and are located in the Washington, D.C. to Boston northeast corridor of the U.S. The strategy is working, as Cedar has maintained a 93% same-store occupancy rate since the real estate market imploded in 2007. The company has high leverage with significant maturities coming due in 2012 and that has weighed on the share price. Management is selling non-core assets and moving to deleverage the company.

Cedar Realty has identified 50 properties worth $150 million of assets to be sold or returned to the lender as part of this effort. As part of its effort to concentrate on the more economically sound Northeast corridor, the company is completely exiting the more troubled Michigan and Ohio markets. Cedar is also disposing of all its land for development and stand-alone stores in its portfolio to concentrate on established shopping centers. It is also establishing new credit lines and negotiating extensions on many of its loans to manage the leverage in the portfolio.

Trading at just 50% of tangible book value, the shares are quite cheap. The company just reduced the dividend and projects a dividend for 2012 of $.2 a share. Even after the reduction, the shares yield more than 5%. Management appears to believe in their strategy and future, as officers and directors have been buying the shares in recent weeks. President and CEO Bruce Schanzer bought an additional 20,000 shares last week.

I still own and recommend buying shares of Kite Realty Group (KRG) at current prices as well. This REIT owns 61 properties and has an occupancy rate of operating center of more than 92% this year. Kite also yields more than 5% and the shares trade at 60% of tangible book value.

I have no idea when retail will turn and drive shopping center fundamentals in a positive direction. The economy has been slower to recover that I originally thought it would be when the crisis began. I do know that it will recover at some point, and that the properties bought for a fraction of the underlying value will eventually sell for a premium. I am hopeful that the ones I am buying now are among those that will survive and eventually thrive in the years ahead.

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