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Fund Manager Looks for REITs to Maintain Balance Sheet Stability

06/09/2014 | By Allen Kenney

Scott Craig, portfolio manager and vice president with Eaton Vance, joined REIT.com for a video interview during REITWeek 2014: NAREIT’s Investor Forum, held in New York.

Craig discussed the sources of demand for real estate assets in the current market.

“I’ve been surprised—like many have—that demand has continued to be as strong as it has despite prices that keep getting higher,” he said. “Late last year, a lot of people expected that rising interest rates would cause cap rates to increase also. That didn’t really seem to happen. Cap rates took a bit of a pause, and they’ve just continued their steady march downward from there. Cap rates seem to keep going lower.”

Craig cited public, non-listed REITs (PNLRs) and international sources of capital as two of the major drivers of demand at present.

Craig also offered insight into his current plays on the multifamily and regional mall sectors.

“In both cases, they’re situations where the reality and the perception are disconnected in a way that is leading to attractive stock valuations,” he said.

For example, investors see a looming threat to the mall sector that doesn’t exist, according to Craig.

“A lot of business pundits and a lot of generalist investors seem to fear that the Internet is going to put the malls out of business,” he said. “The reality is that demand is very strong.”

Craig pointed out that high-end malls are operating at near capacity and have waiting lists to fill space.

“Sales are increasing,” he noted. “Retailers want to grow. There are essentially no malls under construction. So, fundamentals are really good despite these fears in the business press that the Internet is going to hurt the malls. We don’t see it yet.”

Craig said investors fear that the improvements in the single-family housing market will hurt demand for apartments. However, occupancy rates remain high and rental growth has stayed strong, he said.

Turning to REITs’ capital structures, Craig acknowledged that he has some concerns about how REITs are managing their balance sheets.

“Early in the financial recovery, a lot of REITs were talking about very heavily equitizing their capital deployment—issuing a lot of equity to buy or build properties,” he said. “As we got further into the recovery, you heard more companies talk about funding their activity in a balance sheet-neutral fashion. Now, I’m hearing more companies funding their activities purely with debt and counting on cash flow growth to fund their de-levering over time. I don’t think that’s a healthy development.”