Citi's $14.28 million notes tied to iShares Dow Jones Real Estate shows taste for REITs

By Emma Trincal

New York, March 30 - Citigroup Funding Inc.'s $14.28 million sale of notes linked to the iShares Dow Jones U.S. Real Estate index fund, amid other deals tied to real estate, indicates a renewed appetite on the part of investors for this asset class.

The 0% jump securities are due March 28, 2012, according to an FWP filing with the Securities and Exchange Commission.

If the index fund's final share price is greater than the initial share price, the payout at maturity will be par of $10 plus 35%. Investors will be exposed to any share price decline.

Citigroup Global Markets Inc. is the underwriter.

Rallying trend

The iShares Dow Jones U.S. Real Estate index fund reflects the performance of the real estate sector of the U.S. equity market. The exchange-traded fund has risen by 9.4% this year.

"The ETF has been going up since mid-February. It's mirroring the economic recovery," said Jim Delaney, portfolio manager with Market Strategies Management.

"This is part of the rally we've seen that began last month. Correlation between asset classes is at one right now. If you have a rally in equity, you're going to have a rally in real estate stocks as well," said Delaney.

Since early last month, the iShares Dow Jones U.S. Real Estate index fund has risen by more than 18%.

"Before mid-February, you had the Greek incident. People were wondering if the crisis was going to spread," Delaney said.

"But now they realized that it may not spill over, and so you see a greater appetite for risk and for stocks. Consequently, REITs went up and made new highs," he said.

Attractive structure

Kirk Chisholm, principal and wealth manager at NUA Advisors, suggested that the structure offered by Citigroup may have been appealing for all category of bulls, including the moderately bullish investors since investors will receive their 35% payout as long as the underlying finishes higher after two years no matter by how much.

"For people who are going to allocate to real estate anyway, I think the notes are a good substitute to a sector ETF because it's unlikely that real estate will go up by 35% in two years due to market fundamentals," said Chisholm.

"And if you were in the index directly, you would get the same downside exposure than with the notes. So from an allocation standpoint, I think it's an attractive investment for a sector that may not have a 35% upside in the next two years," Chisholm added.

Real estate mania

The deal came to market among other offerings and announcements, reflecting the current popularity of the sector.

Citigroup priced $1.31 million of 0% buffer notes due Sept. 26, 2011 based on the iShares Dow Jones U.S. Real Estate index fund.

The payout at maturity will be par of $10 plus 1.5 times any fund gain, up to a maximum return of 18%. Investors will receive par if the shares fall by up to 15% and will lose 1% for every 1% decline beyond the buffer.

Barclays Bank plc priced $1 million of zero-coupon non-principal-protected bearish notes due Jan. 9, 2012 based on the performance of the Radar Logic Residential Property index.

The payout at maturity will be par of $10,000 times 96.2% minus the index return. If the final index level does not decline by 3.8% or more, investors will lose at least some of their investment.

This index is designed to reflect the median price per square foot of residential properties in 25 metropolitan statistical areas in the United States as averaged over rolling 28-day periods.

On Tuesday, JPMorgan Chase & Co. priced $122,000 of 0% semiannual review notes due Sept. 30, 2011 linked to the iShares Dow Jones U.S. Real Estate index fund.

If the ETF's shares close at or above the initial share price on Sept. 27, 2010, March 29, 2011 or Sept. 27, 2011, the notes will be automatically called and investors will receive par plus a call premium of 17% per year.

If the notes are not called and the final share price is at least 80% of the initial share price, the payout at maturity will be par. Otherwise, the payout will be par plus the fund return.

Meanwhile, Barclays plans to price 0% buffered iSuper Track notes due April 10, 2013 linked to the iShares Dow Jones U.S. Real Estate index fund.

Small retail products

"You have a bunch of different things, but overall these are really small deals," said a sellsider.

"I think banks are trying to explore different ways to play real estate, although I'm not sure why the same issuer would show bullish and bearish notes. A bearish product would cost more, so I think they'll go for bullish notes looking forward, which will give them the opportunity to offer better pricing" he said.

This sellsider said that investors for those deals were "more than likely" retail clients given the size of the proceeds and the fees.

The Citigroup jump securities for instance carried a 2.25% fee.

The Barclays bearish notes linked to the Radar Logic Residential Property index had a 1.5% fee.

"Retail is always behind institutional. They saw the index jump by 10%, and so now you have a strong retail demand, which is why fees are rather high," the sellsider. "We may see more volume in a few weeks, but I doubt it," he said.

Contrarian hedges

Some experts in real estate stocks are cautious and have a mixed or even bearish outlook on the sector.

"We don't think REITs are tremendously undervalued. If anything, the sector is slightly overvalued. There's nothing screaming one way or the other," said Jason Ren, equity analyst at Morningstar.

"We have a negative outlook on REITs for 2010," said Steven Marks, managing director and REIT group head at Fitch Ratings. "The fundamentals of commercial real estate are going to continue to be weak this year, and that's driven by high unemployment, weaker consumer demand and reduced business activity. In addition, the sector remains overleveraged."

These views may incite issuers, as Barclays recently did with its zero-coupon non-principal-protected bearish notes, to widen their offerings of real estate index-linked notes. Adding bearish notes may reflect the market uncertainty and the need to hedge, said Delaney.

"When you have a bullish and a bearish product coming from the same institution, it's like killing two birds with one stone," said Delaney. "The same institution can offer the two sides of the same trade as they're partially hedged. They may also do that to test the water."

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