If you want to understand how nervous real estate investors are these days, take a look at Mills Corp., the company that owns Potomac Mills, Arundel Mills and dozens of other mega-malls.
Mills' stock price plunged 15 percent last Tuesday, its biggest daily loss ever, after the Arlington-based company delayed release of its second-quarter financial report for a week and warned that third-quarter results "will be substantially below expectations."
Four Wall Street firms promptly cut their rating on Mills stock, with three slashing it to "neutral" and one to "sell." In Baltimore, Legg Mason real estate analyst David Fick suspended his rating on Mills, writing that it was impossible to make a recommendation because the company is "stonewalling" on its finances.
"The management did itself and shareholders a huge disservice" in its handling of the situation, Fick wrote. "The company probably did more damage with the way it presented the issue than the reality."
Tuesday's announcement knocked $300 million off the stock market value of Mills, a real estate investment trust. Its share price has fallen 30 percent so far this year and closed Friday at $44.62.
The company plans to issue its third-quarter report Wednesday. A spokesman said only that the delay in issuing the report is not a symptom of ongoing accounting problems like those that have plagued so many companies recently.
Mills is the latest REIT to feel the heat that higher interest rates are putting on the stocks of real estate and home-building companies, which in recent years have been some of the best-performing investments available.
Not anymore. REIT shares have dropped 11 percent since they peaked in early August, as measured by the NAREIT composite price return index. NAREIT is the National Association of REITs.
The index is down about 2.3 percent this year, reflecting the slump in stock prices. Because REITS pay out most of their profits in dividends, investors in the index stocks have still posted a 2.4 percent total return so far this year.
But with falling stock prices offsetting much of the quarterly dividends, REITs have done no better than the overall market this year, one of many signs that the real estate sector's six-year run is running out of steam.
The stocks of six of about a dozen REITs that are based in the District, Maryland and Virginia are down for the year. In addition to Mills, the losers are Washington REIT, which owns several types of properties in the area; Saul Centers Inc., a shopping-center specialist; Highland Hospitality Corp. and Host Marriott Corp., both of which own hotels; and CarrAmerica Realty Corp., a major office developer.
Nationally, third-quarter financial reports forecast a slowdown. Six out of seven REITs that recently changed their projections for 2006 revised them downward, Citicorp noted. Of 13 REITs that gave new guidance on fourth-quarter performance, eight pushed their profit projections down while five raised them.
At the REIT industry's annual convention in Chicago last week, predictions were that REIT shares will end this year down or flat and are likely to fall next year -- as much as 20 percent, by one estimate.
Optimists outlined scenarios in which REITs would prosper next year, but they were based on predictions that an economic slowdown will force the Federal Reserve to cut interest rates by midyear, unlikely in the view of most Fed watchers.
Rising interest costs have been a threat to the REIT industry since the Fed began raiding rates almost 18 months ago. Rates did not pinch as soon as many people expected, however, because for many months long-term rates -- especially mortgage rates -- did not move up with the short-term rates that are set by the Fed.
Now long-term rates are catching up. In the past six weeks, rates on 30-year home mortgages have increased by half a percentage point to 6.31 percent, the highest in a year and a half. Big property owners don't borrow in the mortgage market, but home-loan rates roughly track trends in commercial property lending, where financing tends to be far more complex than home mortgages.
As rates rise, the margin for error on real estate investments narrows. It's pretty easy to make money in real estate when you can borrow at the lowest rates most landlords have experienced in a lifetime. It's not so easy when the cost of money returns to normal.
And as rates rise, other less-risky investments become more attractive than REITs. Treasury bonds now pay 4.67 percent, which puts them in the same range as the dividend yields of many REITs.
Still, two local REITs were trading at record prices last week.
Shares of Town & County Trust, a Baltimore apartment REIT, hit an all-time high of $30.19 on Thursday and closed Friday at $29.95, up 8.4 percent since January.
And shares of American Community Properties Trust hit a record $26.35 on Tuesday and closed Friday at $25.25. It is one of the region's hottest stocks this year, gaining 108 percent. American Community Properties is based in St. Charles, the 9,000-acre project the company is developing in Charles County.
But even those record stock prices can be seen as red flags. Valuations are becoming an issue for some REIT investors who worry that the stock prices are too high, particularly compared with dividends. When REITs rise to the point that their dividends yield little more than bonds, it's time to sell, those investors argue.
The founders of the region's most unusual REIT have decided this is a good time to cash out. In September, Capital Automotive REIT, which owns auto showrooms, lots and service facilities that it buys from dealers and leases back to them, accepted a $38.75-a-share buyout offer from DRA Advisors LLC, a New York firm that manages real estate for pension funds and other institutional investors.
Known by its trading symbol, CARS, Capital Automotive was founded in 1998 by a group of Washington car dealers who kicked in their own real estate and sold stock to the public for $15 a share.
Seven years later CARS owns almost 350 showrooms. But its stock price has lagged behind that of other REITs because of the sorry state of the Detroit automakers. All the property owned by CARS is fully leased, and none of the dealerships is having trouble paying rent. But with General Motors and Ford reporting sales off 26 percent last month, car dealerships are considered risky tenants.
DRA offered to pay a 9 percent premium over what CARS stock was trading for in early September, when the sale was announced, which will mean big paydays for early investors.
Local car magnate Robert M. Rosenthal, one of CARS's founders, owns 2.7 million shares and stands to take out about $105 million. Co-founder John J. Pohanka, with 1.2 million shares, will collect about $48 million when the deal closes in a few months.
Capital Automotive is one of several REITs that have been sold in the last few months -- and some analysts say a sale could be in the cards for Mills Corp.
Potential buyers, according to Legg Mason, include KanAm Realty Inc., a longtime partner of Mills; Vornado Realty Trust, which bought the District's Charles E. Smith Cos.; and Westfield Properties, the Australian real estate company that owns what used to be called Montgomery Mall and Wheaton Plaza.
One reason for the sale speculation is that Mills is losing three top executives. Kenneth R. Parent, the chief operating officer, announced that he will retire next April. Executive Vice President Thomas E. Frost will retire at the end of the year. Michael J. Green, chief accounting officer, left to take another job.
None of those departures reflects internal management problems at Mills, analysts say, but there are concerns about the company's ability to pull off its most ambitious project -- turning a New Jersey swamp into a giant shopping, entertainment and office project called Xanadu.
The property is next to the Meadowlands sports complex where New York's professional football teams play. A new stadium for the Jets and Giants and a minor league baseball park are to be built alongside the Mills project.
The retail and entertainment complex will be 50 percent bigger than Potomac Mills. Add hotels, offices and other facilities and the Meadowlands project will total 4.8 million square feet -- more than three times the size of Potomac Mills. Construction started last spring, with completion scheduled for the end of 2007.
Complications in the financing and accounting for Xanadu could be one of the reasons Mills is having trouble closing its books for the third quarter, analysts said. And the project could also be one of the assets that would make Mills very attractive to potential buyers.
Jerry Knight's e-mail address is firstname.lastname@example.org.