Big Coastal Cities Are Key For REITs

By Aaron Levitt | August 24, 2011 AAA

Investors in commercial real estate have certainly had a lot to smile about over the last 2 years. Hit hard by the global credit crisis and resulting recession, prices for commercial real estate have bounced back. Funds like the First Trust S&P REIT Index (NYSE:FRI) have seen their share prices rise as investors have sought protection in real assets and solid dividend payers. However, with the recent outpouring of bad data about the health of the global economy, some analysts are now pointing to another recession. For investors in commercial real estate, it might be time for some defensive action.
TUTORIAL: Exploring Real Estate Investments

Focusing on Strong Cities
As the commercial real estate sector recovered from its recessionary lows, many institutional investors began looking into secondary markets such as Minneapolis as way to profit from the economic expansion. Yields for these "B" markets represented a much higher proposition than prime cities such as New York and Washington D.C. However, with the recent string of bad economic data, commercial property buyers may shift their focus back to the big coastal cities.

Over the last few weeks, many investors across a variety of asset classes have begun to shun risk. Commercial real estate is no different. As property buyers look to shun risk, core and premier properties located in major cities become a necessity. Overall, prime locations such as Chicago, Washington D.C. and New York did not suffer as much as the rest of the United States during the economic downturn. New York real estate prices still remain robust. For example, rents for retail locations in popular tourist spots in New York can go for as much as $2,000 per square foot. According to data supplied by industry group CoStar (Nasdaq:CSGP), property values and rental rates don't rise as quickly in secondary markets when compared with land-constrained coastal cities because it is easier to construct new buildings.

With the economy perhaps stalling, capital investment in real estate will ultimately go towards quality of locations and quality properties. That trend seems to be coming true. During the first six months of 2011, the number of transactions in Manhattan rose 151% and D.C. saw a 71% increase versus 2010 numbers. In addition, these premier locations are attracting much interest from foreign buyers. The number of international buyers in the U.S. commercial real estate sector is steadily rising as favorable currency conditions are helping with purchase prices. These foreign buyers are attracted to these prime cities. (For related reading, see Introduction To International REITs.)

Playing the Shift
For investors in the commercial real estate space, this shift away from the secondary markets and towards premier cities could have some dramatic effects on their portfolios. To that end, playing defense now may be a good idea. Shifting to a fund like the iShares Cohen & Steers Realty Majors (NYSE:ICF) which focuses on 30 largest REITs in these strong markets might be a good decision. However, there are other ways to play the shift. Here are a few picks.

Concentrating on major markets such as Boston, D.C. and Manhattan, the trio of Vornado (NYSE:VNO), SL Green (NYSE:SLG) and Boston Properties (NYSE:BXP) could be all investors need to play the shift. The three REITs provide access to nearly 200 million square feet of real estate in these markets as well as treasury beating dividends. Look for their share prices to continue growing as investors focus on the shift to quality.

Apartment REITs in these key coastal cities are also seeing their status on the rise. Broad-based apartment trust UDR (NYSE:UDR) has continued its buying binge of New York properties. CEO Tom Toomey recently said "the company is focused on buying assets in coastal markets with higher rent levels." Overall, the REIT wants to own nearly $1.8 billion worth of Manhattan apartments. The company also plans to move into urban Boston. Shares of UDR yield 3.3%. (Here we take a look at REITs, their characteristics and how they are analyzed. For more, see How To Analyze Real Estate Investment Trusts.)

The Bottom Line
As the economy begins to slow down, many analysts in the commercial real estate sector are pointing to a shift towards quality properties. Premier cities such as San Francisco or New York will ultimately benefit from investors seeking quality. The previous firms along with Corporate Office Properties Trust (NYSE:OFC), which has about 60% of its properties in Washington D.C., are a great way to profit from the shift.

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