Tide Turning in Real Estate Markets; Self-Storage to Outperform the Rest

Posted on Dec 30 2009 - 7:32am by Winnie Hsiu

The Wall Street Journal this morning predicted a much more stable real estate market for 2010 than the wild ride the market took investors for in 2009. At the beginning of the year, it was much harder for real estate investors to get credit. As a result, the market was down. In fact, it was crashing. By early March it had tumbled 76% from its February 2007 peak. “If you go back to the beginning of 2009, the market was staring into the abyss,” commented Alexander Goldfarb in today’s WSJ. Goldfarb is an analyst at Sandler O’Neill & Partners LP. 

Real estate investors began to feel more hopeful, though, as time went on. On Dec. 7, Marc Holliday, the CEO of SL Green Realty in Manhattan, told a meeting of investors that, “I can now confidently say that the worst is behind us.” At the beginning of 2009, SL Green was struggling to stay afloat, but now it has started to buy real estate again. Many investors, like SL Green, view the current market as an opportunity. Hopeful investors at the end of 2009 focused in large part on hotel and regional mall REITs. Hotels and malls tend to be very sensitive to recessions because people travel and shop less when the economy is bad. At the same time, however, hotels and malls are one of the first types of businesses to start to benefit when times get better. Hotel REITs improved by almost 70% toward the end of 2009. Regional mall REITs went up 64%. 

Meanwhile, the WSJ reports that the Dow Jones Equity All REIT (Real Estate Investment Trust) Total Return Index is up 31% this year, which means that it has improved over its 2008 performance, when it was down 38%. In 2009, the real estate market showed its strongest performance since 2006. It even outdid the Standard & Poor’s 500-stock index, which posted a 25% return. “It’s been very much a roller coaster ride this year,” noted Goldfarb. “And we’re about to end this year on a high note.” 

Ending on a “high note” may be a bit of an exaggeration. The market’s upswing at the end of this year was not due to any actual improvement in the economy, but rather had to do with investors’ tendency to buy low in the hopes of selling high when the market improves. Although the recession’s tide may have started to turn, real estate in general is still not the safe investment that it once was. Reflecting on the condition of REITs, Mike Kirby, chief analyst for Green Street Advisors, a real-estate research firm, told the WSJ that REITs may never again be regarded as “a safe, boring, high-yielding investment….Their leverage makes them something that’s not quite a pure play on real estate and adds a lot of volatility,” he noted. Another analyst, Chris Lucas of Robert W. Baird & Co., told the WSJ that “A lot of the upside has been soaked up out of the big names at this point…things feel pretty overvalued.”

One part of the market that analysts say is not overvalued, however, is self-storage. Lucas told the WSJ that he expected self-storage to be one of three types of REITS that will outperform the rest of the market (the other two are industrial and student-housing REITs). Self-storage can be expected to do well because it does not depend on the creation of new jobs. The recession has been less damaging to the self-storage industry, in general, than it has been for other real estate businesses. According to Inside Self Storage, this is partly because self-storage owners use 30-day leases, and therefore have the flexibility to change their rates immediately in response to changes in the market and to changes in demand. ISS also attributes the stability of self-storage companies to the fact that self-storage business owners, unlike the REITs Kirby refers to, tend not to over-leverage their businesses — they are more likely to keep their leverage within responsible limits. As a result, they are less vulnerable to sudden shifts in the market. 

Overall, the real estate market for 2010 is still volatile, and involves a certain amount of risk. The self-storage market, however, is relatively stable — still a safe investment for 2010 and beyond.