By Ralph Block

To buy or not to buy—that, with apologies to Shakespeare, is the question. In a world of generous pricing for commercial real estate, REIT executives may be asking themselves "whether 'tis nobler...to suffer the slings and arrows" hurled at them by shareholders outraged at the acquisition of properties at today's low cap rates or, instead, "to sleep, perchance to dream," by simply shunning property purchases despite REITs' access to what has been, until recently, cheap capital. Or, to put it simply, is buying commercial real estate at today's market prices an intelligent strategy that's likely to be applauded by shareholders?

Unfortunately, the "right" answer is elusive, and may depend, in large part, upon what shareholders are looking for in their choice of REIT stocks. Our industry has enjoyed a significant increase in fund flows during most of the past few years, and many new investors are yield-oriented; they would be quite happy with a "what you see is what you get" scenario, i.e., the dividend is all-important, with increases in cash flows just icing on the cake. REITs with shareholders who are delighted with a safe 6 percent yield and 2 percent average annual price appreciation (based on 2 percent increases in cash flows and dividends) shouldn't be reluctant to buy properties at current prices and cap rates—particularly if fresh equity can be raised at prices at, or modestly above, estimated net asset values (NAVs).

Of course, buying apartment, office or retail assets at a market price in a very competitive environment doesn't normally create any incremental value for shareholders, nor any accretion in per share NAVs. However, significant value creation may not be a high priority with shareholders of many REITs, and their objectives may be sustained if additional properties can be acquired at internal rates of return (IRR) that match the REIT's weighted average cost of capital. Assuming a long-term debt cost of 6 percent and a cost of equity of as low as 9 percent, along with 50 percent leverage, a REIT's weighted average cost of capital would be 7.5 percent, and many decent properties can be acquired, even today, at cap rates and IRRs north of that.

But shareholder expectations are much higher for another group of REITs whose stock prices exceed estimated NAVs by a substantial margin. Investors in these REITs expect—even demand—that the management teams continue to create significant incremental value for shareholders. They would be sorely disappointed if their REITs become larger in size but don't deliver NAV increases.

My guess is that the shareholders of CenterPoint Properties Trust (NYSE: CNT), Chelsea Property Group (NYSE: CPG), Kimco Realty Corporation (NYSE: KIM) and a significant number of others would hurl more at their management teams than just slings and arrows if they pay market prices for large amounts of fully leased properties with little upside. These shareholders expect—or at least they should expect—much more. Mere FFO accretion won't cut it.

The issue of whether to buy or not to buy is a thorny one, and depends upon the REIT's cost of capital, available opportunities and shareholder expectations. Shifting from Shakespeare to Socrates, my advice to each REIT is to "know thyself"—and to "know thy shareholders."