Morningstar Advisor - February/March 2009 - 57

REITs to Avoid Company Morningstar Rating Fair Value Estimate Fair Value Uncertainty YTD Return % Dividend Yield % Forest City Enterprises FCE.A Maguire Properties MPG General Growth Properties GGP Q Q Q 0.00 0.00 0.00 Very High Very High Very High –84.6 –95.0 –96.7 27.40 3.00 116.28 REITs to Consider Company Morningstar Rating Fair Value Estimate Fair Value Uncertainty YTD Return % Dividend Yield % AMB Property Corporation AMB HRPT Properties Trust HRP Diamondrock Hospitality Company DRH Developers Diversified Realty DDR First Potomac Realty Trust FPO Data as of Dec. 31, 2008 QQQ QQQQQ QQQQ QQQQ QQQQ 27.00 8.00 10.00 14.00 17.00 High High Very High Very High High –58.0 –49.8 –63.8 –86.5 –40.9 8.80 24.93 19.53 55.94 14.62 50%, which tells me that this firm won’t have to deleverage at an inopportune time. In contrast, ProLogis is at nearly 70%, when more than 60% is generally deemed unacceptable, especially today. This means that as debt comes due, ProLogis will only be able to refinance a portion of the capital and must pay the rest with cash. Because most REITs have very little cash on their balance sheets, the only way to reduce debt is to sell properties in the currently inhospitable environment. Other important leverage metrics we look at are earnings before interest, taxes, depreciation, and amortization relative to interest (2.5 times for AMB and 1.8 times for PLD) and total debt relative to EBITDA (10 times for AMB and 15 times for PLD). Clearly, AMB is in a much better capital position. After becoming comfortable with the balance sheet, we turn to our cash-flow forecasts and various valuation triangulation methods to determine what the stock is worth. We then compare this value with the stock and decide if it’s over- or undervalued. One triangulation method in particular that I’m fond of is the free-cash-flow yield of a stock at our Consider Buying price (the price at which the stock would be given a 5-star Morningstar Rating for stocks). This method basically tells me the cash the company produces after expenses in relation to the amount of money I invest in the stock. In today’s much-higher-return environment, where preferred equity and debt yields are often in the double digits, I think there is very little reason to accept less than a 10% free-cash-flow yield on common equity, and depending on the situation, even higher. So far, this strategy has worked out well for our team: It provides an attractive margin of safety in a highly uncertain world. K Haywood Kelly, CFA, is vice president of equity research at Morningstar. tapped aggressively to fund acquisitions, new developments, and redevelopments of existing properties. Unfortunately, profitability projections put in place when new projects were started are proving very optimistic, making current debt loads at several firms appear onerous. Therefore, we think investors who want exposure to REITs are better served picking companies that don’t fall into this category, because those who just buy an index are nearly guaranteed to see several of its constituents go bankrupt. HK: Your team has a handful of 5-star stocks. Which ones offer the best combination of value and financial strength? JB: The valuations on several REITs have amount of debt on the balance sheet, good coverage of interest by cash flow, and at least a decent property portfolio. HK: Your team does a lot of work stress-testing your fair value estimates and cross-checking against other valuation approaches. Could you walk me through an example—perhaps with one of your team’s 5-star stocks? JB: Sure, let’s look at AMB Property Corp. AMB. To put things in perspective, I’ll compare and contrast AMB with its much less attractive competitor, ProLogis PLD. become so compressed that many are undeservedly pricing in a high probability of bankruptcy, in our opinion. While we have a negative outlook, we certainly don’t expect all REITs to go to zero. Through research that sometimes resembles that of a credit analyst rather than an equity analyst, we’ve been able to surface several names that are priced for an outcome much more dire than we think is reasonable. The common theme among these companies is a reasonable One of the first places I look in valuing REITs these days is the balance sheet. I’m already comfortable saying that nearly every REIT will see cash flow decline in the near term. What I need to know immediately, though, is whether or not the company has the liquidity to withstand not only falling cash flows, but extremely unreceptive credit markets. One of the primary metrics we look at in this respect is total debt relative to gross property, plant, and equipment, which is similar to a loan/value ratio commonly quoted in residential real estate. For AMB, this number is below MorningstarAdvisor.com 57
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Morningstar Advisor - February/March 2009

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2009

Morningstar Advisor - February/March 2009
Contents
New on MorningstarAdvisor.com
Letter from the Editor
Contributors
Inbox
How Do You Gauge and Measure Risk?
No Skinny-Dippers Here
Heading to Shore
Investment Briefs
Weapons of Mass Destruction?
Déjà Vu All Over Again
A Failure to Gauge Risk
Five Areas to Find Opportunities
Getting a Read on Risk
Heavenly Returns
Greenspring Comes to the Rescue
How to Spot a Trustworthy REIT
Four Picks for the President
Find Succor in These Large Dividends
These Stocks Are Fiscally Fit
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks
Most Popular Variable Annuities
New at Morningstar
You Gotta Look Sharpe
Morningstar Advisor - February/March 2009 - Intro
Morningstar Advisor - February/March 2009 - Morningstar Advisor - February/March 2009
Morningstar Advisor - February/March 2009 - Cover2
Morningstar Advisor - February/March 2009 - 1
Morningstar Advisor - February/March 2009 - 2
Morningstar Advisor - February/March 2009 - Contents
Morningstar Advisor - February/March 2009 - 4
Morningstar Advisor - February/March 2009 - 5
Morningstar Advisor - February/March 2009 - New on MorningstarAdvisor.com
Morningstar Advisor - February/March 2009 - 7
Morningstar Advisor - February/March 2009 - 8
Morningstar Advisor - February/March 2009 - Letter from the Editor
Morningstar Advisor - February/March 2009 - Contributors
Morningstar Advisor - February/March 2009 - Inbox
Morningstar Advisor - February/March 2009 - How Do You Gauge and Measure Risk?
Morningstar Advisor - February/March 2009 - 13
Morningstar Advisor - February/March 2009 - No Skinny-Dippers Here
Morningstar Advisor - February/March 2009 - 15
Morningstar Advisor - February/March 2009 - 16
Morningstar Advisor - February/March 2009 - Heading to Shore
Morningstar Advisor - February/March 2009 - 18
Morningstar Advisor - February/March 2009 - 19
Morningstar Advisor - February/March 2009 - Investment Briefs
Morningstar Advisor - February/March 2009 - 21
Morningstar Advisor - February/March 2009 - Weapons of Mass Destruction?
Morningstar Advisor - February/March 2009 - 23
Morningstar Advisor - February/March 2009 - 24
Morningstar Advisor - February/March 2009 - 25
Morningstar Advisor - February/March 2009 - 26
Morningstar Advisor - February/March 2009 - 27
Morningstar Advisor - February/March 2009 - Déjà Vu All Over Again
Morningstar Advisor - February/March 2009 - 29
Morningstar Advisor - February/March 2009 - 30
Morningstar Advisor - February/March 2009 - 31
Morningstar Advisor - February/March 2009 - 32
Morningstar Advisor - February/March 2009 - 33
Morningstar Advisor - February/March 2009 - A Failure to Gauge Risk
Morningstar Advisor - February/March 2009 - 35
Morningstar Advisor - February/March 2009 - 36
Morningstar Advisor - February/March 2009 - 37
Morningstar Advisor - February/March 2009 - Five Areas to Find Opportunities
Morningstar Advisor - February/March 2009 - 39
Morningstar Advisor - February/March 2009 - Getting a Read on Risk
Morningstar Advisor - February/March 2009 - 41
Morningstar Advisor - February/March 2009 - 42
Morningstar Advisor - February/March 2009 - 43
Morningstar Advisor - February/March 2009 - 44
Morningstar Advisor - February/March 2009 - 45
Morningstar Advisor - February/March 2009 - 46
Morningstar Advisor - February/March 2009 - 47
Morningstar Advisor - February/March 2009 - Heavenly Returns
Morningstar Advisor - February/March 2009 - 49
Morningstar Advisor - February/March 2009 - 50
Morningstar Advisor - February/March 2009 - 51
Morningstar Advisor - February/March 2009 - Greenspring Comes to the Rescue
Morningstar Advisor - February/March 2009 - 53
Morningstar Advisor - February/March 2009 - 54
Morningstar Advisor - February/March 2009 - 55
Morningstar Advisor - February/March 2009 - How to Spot a Trustworthy REIT
Morningstar Advisor - February/March 2009 - 57
Morningstar Advisor - February/March 2009 - Four Picks for the President
Morningstar Advisor - February/March 2009 - 59
Morningstar Advisor - February/March 2009 - Find Succor in These Large Dividends
Morningstar Advisor - February/March 2009 - 61
Morningstar Advisor - February/March 2009 - These Stocks Are Fiscally Fit
Morningstar Advisor - February/March 2009 - 63
Morningstar Advisor - February/March 2009 - Mutual Fund Analyst Picks
Morningstar Advisor - February/March 2009 - 65
Morningstar Advisor - February/March 2009 - 66
Morningstar Advisor - February/March 2009 - 67
Morningstar Advisor - February/March 2009 - 50 Most Popular Equity ETFs
Morningstar Advisor - February/March 2009 - 69
Morningstar Advisor - February/March 2009 - 70
Morningstar Advisor - February/March 2009 - 71
Morningstar Advisor - February/March 2009 - Undervalued Stocks
Morningstar Advisor - February/March 2009 - 73
Morningstar Advisor - February/March 2009 - 74
Morningstar Advisor - February/March 2009 - 75
Morningstar Advisor - February/March 2009 - Most Popular Variable Annuities
Morningstar Advisor - February/March 2009 - 77
Morningstar Advisor - February/March 2009 - 78
Morningstar Advisor - February/March 2009 - New at Morningstar
Morningstar Advisor - February/March 2009 - You Gotta Look Sharpe
Morningstar Advisor - February/March 2009 - Cover3
Morningstar Advisor - February/March 2009 - Cover4
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