Real estate investment trusts, or REITs, have been around for more than half of a century, but
given fundamental changes in the national economy, you have to wonder if REITs
can evolve and catch the latest trends.
REITs were first
authorized under the Cigar Excise Tax Extension of 1960. In basic terms, there are equity REITs, which own large properties such as malls, office
towers and apartment projects and get their money largely from rent, and mortgage REITs, which hold mortgages and
mortgage-backed securities. Most REITs are equity REITs.
REITs are shareholder-owned. As with any investment, share
values can rise and fall. Unlike listed companies, however, special rules apply
to REITs. According to the National Association of Real Estate Investment
Trusts, “at least 75 percent of a REIT’s total assets must be invested in real
estate; and at least 75 percent of gross income must be derived from real
estate sources, such as rents from real property, interest from mortgages on
real property or sales of real estate investments. REITs also must be widely
held, with more than 100 shareholders and no fewer than five individuals owning
more than 50 percent of their stock.”
What REITs really do is give small investors the chance to
own big real estate properties, properties with economies-of-scale normally
off limits to all but the rich and famous. The catch is that the traditional
assumptions which power such investments are now in flux and so one has to ask:
Can REITs evolve with the times?
Shopping Malls.Depending on who you ask, shopping malls are either on the
way out or on the verge of a massive rebirth. In either case there will be
fewer of them. According toJeff
Macke, host of Yahoo! Finances Breakout, and a former hedge fund manager, “a decade ago there were more than
1,100 enclosed shopping malls in the US Since then, more than 400 have either been repurposed or closed outright.” Macke estimates that in 20 years the number
of shopping malls will be halved.
For REITs, the challenge is obvious: If malls are closed and
abandoned, then where are the rents? Or, are malls closures a good thing, a chance
to create new revenue streams by building town centers, community colleges,
mixed-use properties and other hubs?
Online shopping. Today, online revenues represent about 6.5 percent of all
retail sales, and for an example, its hard to miss Amazon, a company which racked up nearly $75 billion in online sales in 2013. In theory, its money that may have once have gone to malls and strip centers, money those malls certainly could have used. However, blaming the demise of shopping malls on online shopping alone is not right.
First, the real issue represented by online retailers is
choice. You can go to the mall today, see and touch whatever you want, then
check prices with a cell phone (a practice known as showrooming) and have items delivered to your front door – often
with no charges for shipping or taxes. Or, you can simply skip the mall, save gas and avoid parking hassles by shopping online.
For REITs, the question is where the new opportunities
created by online commerce can be found, an area sure to grow. For instance, if
REITs can own malls then why not fulfillment centers and server farms? Maybe
the property mix should be changed to include more strip centers, places where
people can pick up both milk and online orders. Or perhaps the highest and
best use of todays shopping centers is not as a mall at all, but as a
something different, such as a mixed-use development.
Second, a bigger problem than eCommerce is the changing
retail mix. Over time, many department stores have disappeared – think of
Filenes, Bullocks, Thalhimers, Strawbridges, Hechts, Woodward amp;
Lothrop, I Magnin, Wanamaker, Jordan March, Marshall Fields, Daytons, Sterns,
Garfinklels and J.M Fields. These stores had enormous footprints and were
crucial anchors for many malls but as they have merged or gone out of business, the necessity for such vast spaces has declined.
Even on a smaller level, the squeeze is on. Office Depot and
Office Max have merged. Radio Shack is closing more than 1,000 outlets and
Staples has announced plans to close 225 stores.
Mall foot traffic is down nearly 15 percent during last years holiday shopping season, according to the research firm ShopperTrak, and you can see the results in food courts: Sbarro, the pizza
chain, is closing 155 outlets while Hot Dog on a Stick filed for bankruptcy in
February and was sold for $12.2 million in August. Translation: If stores close, theres less reason to go to a mall, and with less foot traffic, food courts feel
For REITs, online shopping presents a host of unknowns. Its here,
it has wallop and yet it also represents potential opportunities. How can local
retail outlets best harness the Internet? We dont know yet, in part because
the retail arena remains in flux.
Telecommuting. There was a space for “work” and a space
for “home,” but now the two are increasingly intertwined. More employees bring their work home while remote homeworkers may never see the inside of an office tower. In both cases, the idea of
a 9-to-5 workday has become both quaint and outmoded: curiosities from a
What we know about telecommuting is that the use of
traditional workspace is eroding. The United States Census Bureau tell us that
in 1997, 9.2 million people out of 132 million in the workforce labored from
home at least one day a week. By 2010, we had 142 million people in the
workforce and 13.4 million worked from home at least some of the time.
In other words, over a period of 13 years, the workforce
increased by 10 million people. Of this increase, 42 percent are
not going to an office park or downtown tower on a daily basis, if at all. In
fact, its increasingly routine for remote workers to have never met co-workers
or visited company offices, people and places who may be thousands of miles
Todays office space has a valuation of roughly $1.25
trillion nationwide, so even small changes can represent big dollar shifts. According toTim Wang, director and head of investment research for Clarion Partners, an investment firm,in article for CoStar Group, a producer of real estate research, the ideal amount of space set aside per employee has gone from 250
square feet to 195 square feet. The implications are enormous.
office workers also mean fewer commuters and less road wear, which is positive for many metro areas and something local governments have reason to
encourage. Second, with shared space and remote workers, companies need less
What are office-owning REITs to do in the face of such
trends? Should they transform existing structures with good locations into residential
properties? Should they upgrade office spaces for greater efficiency? Could they sell off office
assets and invest funds elsewhere? Theres no one answer and certainly theres
no universally “right” response.
In the end, REITs are tied to big real estate and big real
estate is in a period of transition. Its a moment of opportunity, but what is
the opportunity? Time will tell.
Peter Miller is a
nationally-syndicated real estate columnist and the author of six books
published originally by Harper amp; Row. He blogs regularly at OurBroker.com. He is also a contributor to Auction.com.