MAY 2010

Domestic

Real estate investment trusts (REITs), as measured by the FTSE NAREIT Equity Index, outperformed the broad equity markets in May on a relative basis, declining only 5.6% versus a decline of 8.0% for the S&P 500 Index.¹  All major property sectors posted negative returns for the month, reducing much of the year’s previous gains.  Confidence in the recovery of the U.S. economy faltered amid fears of contagion from Europe’s sovereign debt crisis and China’s policy tightening squeezing global growth, negatively impacting REITs, and other risky assets, and benefitting of lower-risk investments.²  Despite recent declines, on a year-to-date basis REITs continue to outperform and have returned 11.1% in 2010, versus a return of -1.5% for the S&P 500 Index.

The Commercial Mortgage Backed Securities (CMBS) market continued to experience ongoing distress, after Fitch announced that a $1 billion net increase in office loan delinquencies helped to fuel a 49 basis points increase in U.S. CMBS delinquencies to 8.0%.³  The largest newly delinquent contributor was the $380 million loan on the Columbia Center in Seattle.  Fitch also announced, in a separate report, that total losses (i.e., loss severities) on problematic CMBS loans liquidated by special servicers in 2009 reached a high of 57%, a significant increase from the 48% loss severity seen in 2008.  The property type with the highest loss severity was the lodging/resorts property sector at 82%.⁴

The top performing property sector within the FTSE NAREIT Equity Index for May was health care (-1.6%), which benefitted from lower sensitivity to the broad economy and attractive yields.  Sectors with strong relative performance included apartments (-2.7%) and self storage (-3.9%).  Apartments were aided by the year-to-date improvements in employment, which supported modest rises in occupancy and rent levels.  While unemployment remains high, job growth in select metropolitan areas benefitted the sector.⁵   Self storage was aided by strong balance sheets, structured leases, and traditional defensiveness during periods of weakening economic fundamentals.  In contrast, the lodging/resorts sector (-13.8%) was the worst performer during the month, and other sectors experiencing losses included the industrial (-10.0%) and mixed use (-9.7%) sectors.  Lodging/resorts’s sharp decline was due primarily to the sector’s sensitivity to shifts in consumer sentiment, which immediately impacts room rates.  As of the end of May, the average U.S. REIT dividend yield was 3.92%, compared to the yield on 10-year Treasuries of approximately 3.61%.

International

International real estate securities significantly underperformed U.S. REITs in May, with the S&P Developed Property ex-U.S. Index declining 11.0% versus a decline of 5.5% for the FTSE NAREIT Equity Index.  Property stocks in Continental Europe were negatively affected by the ongoing sovereign debt crisis in Europe, in addition to an 8.0% decline in the euro against the U.S. dollar.  The U.K. (-11.6%) underperformed with potential changes to the capital gains tax, which weighed on property stocks.  The U.K. was also negatively impacted by weakness in the British pound versus the dollar, which declined 5.2% during the month.

The Asia-Pacific region (-10.5%) fell less than the international index, led by property returns in mainland China (-3.0%) and Hong Kong (-7.0), which experienced smaller declines.  The Chinese government’s efforts to reign in a hyper-accelerating economy began to take hold during the month and state-owned banks are now prohibited from to originating any new loans to projects outside the scope of the 1 trillion yuan stimulus plan.⁶  Property sales in Beijing, Shanghai, and Shenzhen fell by as much as 70% in May from a month earlier.⁷  Japanese real estate (-12.0%) also declined, despite the yen strengthening 3.1% against the U.S. dollar in May.

¹ All performance data from www.nareit.com and www.sp-indexdata.com.  Accessed 8 June 2010.

² Morningstar Direct.

^3-4 LoanCore Capital.  Core Insights – Week Ending 6/4/2010.

⁵ Bloomberg, L.P.  “Apt REITs: Some Silver Linings Despite a “Horrible” Jobs Number”. 7 June 2010.

⁶ CBRE Investors.  Asian Econowatch.  June 2010.

⁷ Bloomberg, L.P.  “China’s May Property Sales Drop in Shanghai, Beijing”.  1 June 2010.