In 1968 at the height, so to speak, of the Vietnam War, U.S. Air Force Major Chet Brown was fresh out of ideas and common sense. Tired, frustrated and on the wrong end of a microphone after a battle for the provincial capital of Ben Tre, he famously allowed that it had become necessary to destroy the town in order to save it. Such is the logic surrounding 9 REIT stock offerings in the first half of 2009.

Undercapitalized and over-leveraged, many REITs had no choice but to enter into dilutive transactions in order to survive. But Like Ben Tre, these 9 REITs have been flattened by massively dilutive equity offerings, and nobody can predict when they will be able to meaningfully grow their dividends again.

Most of these "re-equitizations" were completed overnight within hours of being announced, which is no wonder as they were priced at a huge discount (over 10%) to the previous day's close. Many of these REIT offerings more than doubled the amount of shares outstanding.

The decision to sell massive amounts of discounted stock at a time when rents are declining across the board is tantamount to destroying these REITs. Indeed, dividends were cut almost immediately after these offerings closed. While it's unclear how the new shareholders felt about this little welcoming gift, what is clear is that these stock deals were hugely dilutive, and that will make it extremely difficult to show any meaningful dividend growth for at least the next several years:

NINE NOT SO GOOD REIT DEALS
REIT Name	Increase In Shares Outstanding	Dividend Cut	News
Brandywine Realty Trust	+34%	-67%	BDN
Cogdell Spencer	+74%	-51%	CSA
Camden Living	+13%	-36%	CPT
Duke Realty	+40%	-32%	DRE
Kilroy Realty	+27%	-40%	KRC
Kimco Realty	+39%	-86%	KIM
Prologis	+65%	-40%	PLD
Regency Centers	+14%	-36%	REG
Weingarten Realty	+30%	-52%	WRI

There are many good reasons to invest in REITs right now. REITs typically lead property markets into and out of recessions, and these successful equity offerings indicate that the market is anticipating a recovery. Nevertheless, these 9 REITs are best avoided in favor of others that have not had to conduct such radical recapitalizations.

Suggestions: the adventurous could take a look at Simon Property Group (SPG). SPG also just closed a large equity offering, but dividends were not cut and management said recently that SPG would resume paying all cash dividends in early 2010 (SPG is currently paying dividends in stock, click here for a complete list of REITs paying dividends in stock). SPG owns a portfolio quality assets in good locations, and they have cash to pick up more.

Apartment REITs will benefit from tighter single family lending standards, very favorable long-term demographic trends, and a precipitous drop in the construction of new apartment stock. Check out Mid-America Apartments (MAA), which will definitely be the best performing Apartment REIT for 2009. Equity Residential (EQR) is another Apartment REIT that reported solid Q1 earnings. The Fed's plunge into CMBS via TALF is causing lots of intrigue in the Mortgage REIT world, particularly with Dynex (DX) which invests in both agency and non-agency RMBS and CMBS.

Disclosures: None at the time of publication

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BMO Capital Markets upgraded the U.S. real estate investment trust industry to "outperform" from "market perform" today, and said it believes REITs are at or nearing a turning point.

"We are raising our sector rating ... based on early signs of economic recovery, the competitively advantaged position of the REITs vis-a-vis the broader real estate industry, and valuation, which we think is much closer to the bottom than the top," BMO analysts wrote in a note.

BMO, which also changed its rating on a number of REIT stocks, said public REITs were much better capitalized than their private peers, and their balance sheets were getting stronger.

"Between equity issuances, debt repurchases and secured and unsecured debt refinancings, balance sheets are improving or stabilized," the analysts said.

The analysts, however, still expect real estate fundamentals to decline over the next 12 months.

BMO upgraded four multi-family REITs, including Camden Property Trust (CPT) and said it remained positive on health care REITs.

At the same time, BMO said it remains cautious on office and self-storage REITs.

Specific ratings changes were as follows:

Upgrades:

* Apartment Investment (AIV) to market perform from underperform
* Camden Property Trust (CPT) to outperform from market perform
* Colonial Properties Trust (CLP) to market perform from underperform
* Home Properties (HME) to outperform from market perform
* Kite Realty Group Trust (KRG) to market perform from underperform

Downgrades:

* BRE Properties (BRE) to underperform from market perform
* Essex Property Trust (ESS) to underperform from market perform


Disclosures: None at the time of this writing. BMO is acting as co-lead for an Inland Realty (IRC) secondary (Merrill is the lead).

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Despite the industry wide turmoil in REITs and real estate, the Multifamily Executive News Service reports that Apartment REITs seem to be faring well, according to a recent study from Standard & Poor's Ratings Services.

Things might not look as good as 2006 and 2007, but they still aren't bad, according to George Skoufis, S&P's primary apartment REIT analyst. "In 2008, we expect continued moderation but positive rent growth," he says. "From a fundamentals standpoint, we've seen moderation in rent growth and NOI growth."

Green Street Advisors, based in Newport Beach, Calif., also studies the REIT market and sees positive growth potential. The firm projected that revenue growth would hit 3.8 percent coming into the year, but those projections have since fallen back to the 3.5 percent mark.

"Apartment REITs overall this year should still achieve positive revenue growth, even in the face of a mild recession," says Haendel St. Juste, an analyst with Green Street. "Despite a slowing economy and an increased supply of single-family and condo "shadow rentals" in certain markets, the supply/demand picture is still in pretty good balance."

Skoufis sees the for-sale market troubles as one of the biggest boosts to the supply/demand equation. "Homeownership is coming down," he says. "That will benefit the multifamily sector."

Even with a slight recession, St. Juste thinks multifamily will hold up. "Demand will still be driven from household formation, a declining homeownership rate, and Echo Boomer demand," he says. "Even in periods of very weak job growth, new household formations tend to bottom out at around 500,000 per year, a result of an ever-growing population."

All of these factors help the REITs, of course. S&P sees AvalonBay (BBB+/Positive), Equity Residential (A-/Stable), and Camden (BBB+/Stable) as setting the pace for the multifamily sector, though it recently downgraded both AvalonBay (for its large development pipeline) and Equity (for not having debt protection).

Although BRE Properties (BBB/Stable), Essex Property Trust (BBB/Stable), Post Properties (BBB/Credit Watch) and UDR (BBB/Stable) were at the bottom of the REITs list, Skoufis says they're still fairing well compared to other sectors.

"They're solidly investment grade," Skoufis adds.

Amplifying this point, the National Association of Real Estate Investment Trusts (NAREIT) reported that Residential REITS were the second best performing REIT sector in the first quarter of 2008.

Apartment REITS, which comprise most of the Residential REITS (the balance is composed of manufactured housing REITs), were up 12.29 percent year-to-date. Residential REIT returns increased 11.20 percent in the first quarter. These are impressive figures compared with the Dow Jones Industrials which was down 7.55 percent to start the year.

Apartment REITs' total returns compare favorably with the those of the U.S. REIT market, which was nearly flat for the first quarter of 2008. (The FTSE NAREIT All REIT Index was down 0.42 percent, while the FTSE NAREIT Equity REIT Index was up 1.40 percent.)
By contrast, other market benchmarks dove into negative territory to start the year.

Other than the Dow Jones Industrials, the S&P 500 was down by 9.44 percent, the Russell 2000 dropped by 9.90 percent and the NASDAQ Composite was lower by 14.07 percent.
REIT performance accelerated in March, as the FTSE NAREIT All REIT Index was up 3.88 percent in the month.

“The sub prime mortgage crises did not have a direct negative impact on apartments but did in fact have an indirect positive impact,” says Brad Case, VP of research and industry information at NAREIT. “All those people who could not afford to buy homes had to start renting apartments.”

This, Case believes is the reason Apartment REITS are a safe way to play the real estate meltdown.

“Fundamentals in the REIT industry are pretty strong and there is no real sign that they are likely to weaken anytime soon,” Case concludes.

For more, see "Even Ben Stein Likes REITs".

Click here for an updated list of Apartment REITs, including current yields

Click here for an updated list of REIT dividends being paid in stock, including current "yields"



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Back in 2005, executives at Camden Property Trust (CPT), a REIT specializing in large apartment complexes, were worried. Why had they been unable to maintain their average occupancies at historical levels? They fanned out across the country to talk with CPT property managers, who complained of having to turn down the credit of applicants for $700 a month apartments when home lenders across the street were providing the same questionable applicants with mortgages worth $350,000.

The CPT executives were suspicious about the mortgage credit checks, but they were unable to confirm their hunch. Numerous observers had been monitoring the record growth in the U.S. homeownership rate, including the Boston Globe which published a 2005 article entitled The Dark Side of Subprime Loans. The article was suspicious about “so-called subprime loans” but until the cracks in that market began to appear last spring, there was no way to know for sure what was happening.

What everyone could see, however, was that the U.S. rate of homeownership had reached historically high levels. It was at about that time that both outgoing Fed Chairman Alan Greenspan and incoming Fed Chairman Ben Bernanke both played down the possibility of a so-called “housing bubble”. As it turned out, there was a bubble, encouraged not only by subprime mortages, but also by numerous government policies that encouraged homeownership.

Not surprisingly, the same census data that showed increasing rates of homeownership also showed increasing levels of vacancies in the nation’s rental unit housing stock. Although still higher than average, the national vacancy rate was far outpaced by above average vacancy rates in the Midwest, where homeownership is more much more affordable and economic dislocations have put pressure on the region generally.

While policy makers across the U.S. crowed about delivering the American Dream to ever greater percentages of Americans, the problem for CPT was more immediate: how do we keep our apartments full so we can grow our earnings? CPT, like many apartment owners, had no choice but to reduce their average rents, offer incentives to renew leases, ask for smaller deposits to protect against property damages, and reduce investments in capital improvements. Cumulatively however, these solutions were not much more than a band-aid in the face of a national stampede to homeownership.

Subprime was not the only reason for the increased levels of homeownership. Well-meaning government sponsored loan programs allowed first time home buyers to purchase homes with little or no equity, and tax laws allowed the deduction of home mortgage interest while providing generous shelters for capital gains. At the same time that the subprime market was starting to unravel however, influential law makers were also rethinking the government’s largesse.

In a New York Times article entitled “Mortgage Trouble Clouds Homeownership Dream”, Representative Barney Frank (D) Massachusetts said that United States policies in recent years had promoted the idea of homeownership too hard and at the expense of rental housing. “I wish people could own more homes,” he said in the interview. “But I also wish I could eat and not gain weight.”

Many academicians agreed. In the same article, Joseph E. Gyourko, Professor of Real Estate and Finance at University of Pennsylvania’s Wharton School of Business asserted that "we went too far. It’s not the case that high homeownership is always good.”

These increasing homeownership trends are clearly reversing, and now may be the best time in years to own Apartment REITs. Not only are secular, long-term demographics supporting improved operating fundamentals, but the havoc in the financial markets has discounted all REIT stocks.

REIT stock prices have typically been a good harbinger of property values. When they trade at or below the value of the underlying real estate, as most are now, they have traditionally predicted weakening property values. However, these times are anything but traditional, and commercial property values now are not directly connected to the wider real estate contagion because they produce reliable monthly income.

These income streams determine how commercial property is priced, and the income for apartment buildings looks strong for several reasons. First, commercial development of new-builds in this cycle has been muted by high construction costs. This limited new supply, combined with strong growth in demand from immigration and the “echo-boomers”, should provide a floor under apartment rents. Add in the thousands of households now returning to the rental pool, and apartment fundamentals have never looked more solid.

In addition to these strong operating fundamentals, the Fed has responded to the liquidity crisis by directly intervening in the government agency securities market. I wrote about this unconventional and rarely used Fed operation in a previous article, which was undertaken in an effort to reduce long term borrowing rates. This Fed action, along with its steep reductions in the discount rate, will also help support commercial property prices.

So far, values have held up. The Mortgage Bankers Association reports that in 2007, defaults in Fannie Mae loans for apartment buildings remained flat at .08%, while 2007 defaults among apartment loans sponsored by Freddie Mac declined to .02%. In fact, despite all the bad news in residential real estate, defaults in the broader commercial property sector remain at historical lows. According to the Wall Street Journal, the delinquency rate on the almost $840 billion in outstanding commercial mortgage backed securities is less than .5%. Lenders, particularly Fannie Mae and Freddie Mac, also remain active in the apartment sector, unlike other commercial property markets where liquidity has dried up.

In this market, making a REIT investment of any kind isn't for the faint of heart, but other well run, diversified apartment REITs worth considering include Avalon Bay Properties (AVB), which has a large development pipeline in high barrier markets and low leverage, and Essex Property Trust (ESS), which also operates in high barrier markets and just announced an almost 10% increase in its dividend. Avoid AIMCO (AIV) which operates in low barrier markets like the Midwest and has relatively higher leverage, and REITs like Post Properties (PSS) which had been relying on condo conversions to drive operating results.

Caveats? A deep recession will impact rents no matter how strong the fundamentals. The “shadow” rental market of foreclosed homes will also put some pressure on apartments, but rental homes do not compete directly with apartments. Most renters are not interested in mowing lawns and shoveling snow, and apartment living excuses them from these kinds of responsibilities.

Also, REITS enjoy favorable taxation treatment at the corporate level, so most do not allow for the 15% tax treatment on dividend income. Accordingly, if you decide to do any buying, it should be done in your 401k or IRA. Consider REITs for capital gains though, and think of the dividends simply as the icing on your subprime cake. Click here for a complete Apartment REIT list, including current yields

Disclosure: None