Real estate investment trusts regain public confidence
W. Pearce Coues says the public perception of real estate investment trusts (REITs) has changed ``rather dramatically over the last two or three years.'' During the mid-1970s, these mutual-fund-like financial instruments that let small or big investors put money into real estate suffered severe damage to their reputation when several went bankrupt. Now, says the president of the National Association of Real Estate Investment Trusts, their reputation has greatly improved.
``People are feeling more confident about REITs,'' noted Tim Gallen, an official with Consolidated Capital, manager of a family of REITs based in Emeryville, Calif.
That's shown in the numbers. So far this year, REITs have registered or completed 27 public ``equity'' offerings totaling $2.2 billion. Funds obtained by these offerings of REIT shares, sold to individual or institutional investors, are used for investment in property ownership. During all of 1984, only $711 million from 21 offerings was raised from such equity offerings.
In addition, four REIT debt offerings totaling $1.1 billion have been completed or registered so far this year. This money will be used to buy mortgages or to make construction or other types of loans. Last year, REITs made 10 debt offerings totaling $2.07 billion.
Adding up both financing sides, REITs already this year have surpassed their previous all-time high of some $2 billion of offerings in 1971.
Last year, the total assets of REITs increased substantially for the first time since 1973, reaching $9.7 billion by the end of 1984, up more than $2 billion during the previous 12 months.
Why have investors taken a fresh shine to REITs, the first since the debacle of the 1970s?
Mr. Coues, chairman of Boston-based Mortgage Growth Investors, and other REIT officials cite these reasons:
1. REITs have offered a good return over the last few years (see table).
Figures kept by their national association in Washington show a 3.89 percent improvement in share price last year, plus a 9.2 percent dividend yield, for a total return of 13.09 percent. That is more than twice the 6.2 percent rise in the Standard & Poor's stock price index. The REITs also beat the S&P index by a little in 1983 with a 24.51 percent average total yield and in 1982 with a 27.07 percent yield. In 1981, when stock prices tumbled 5 percent, REITs managed a 9.27 percent total yield.
``I see this group [of stocks] having an emerging attraction for Wall Street,'' says L. Howard Nichol, a vice-president for research with Advest Inc., a brokerage house.
2. The REITs that survived the 1970s troubles have followed much more conservative investment practices since then.
Recalling that period, Mr. Coues noted that some of the REITs, especially those making construction loans as opposed to equity investments in property, were heavily leveraged. Some borrowed five or more times as much as the equity owned by their shareholders. This enabled the REIT to expand its investments rapidly. But it also boosted the risk for the REIT should property values drop and some of the loans be foreclosed.
Today the average ratio of borrowed money to equity money is one to one, says Coues. ``The distinction between then and now is that REITs have learned to grow slowly,'' he says. Most invest for the long-term -- 10 or 15 years. When they borrow, they usually get long-term money from insurance companies or other institutions, rather than short-term funds subject to interest rate fluctuations.
Further, by making loans with variable interest charges, REITs now insure that they keep a profitable spread above the interest rates they pay on their liabilities.
REIT managers, says Mr. Gallen, ``have learned a lot of lessons.''
One survivor of the earlier period, Arthur G. Von Thaden, head of BankAmerica Realty Investors, a San Francisco-based REIT with assets worth $300 million (fair value), says he hasn't made a construction loan since 1973. His bank-sponsored REIT survived the tough times of the mid-1970s because its assets consisted of actual property as well as real estate loans. The assets provided sufficient return that the trust was able to continue paying dividends.
Another REIT set up by a bank holding company, the Chase Manhattan Mortgage & Equity Trust, fared far worse. At one time, it had around $1 billion invested, but mostly in construction loans. It eventually went bankrupt. Investors in that trust saw their shares drop in value from around $73 in 1973 to pennies.
Wells Fargo Mortgage & Equity Trust, another survivor of the 1970s, still has the majority of its portfolio in construction loans -- some $255 million. But financial vice-president Stephen Huber notes that various system changes have been devised to avoid the type of difficulties -- far more modest than the Chase REIT -- it dealt with during the last decade. It, for instance, has its own independent appraisers to look over properties, rather than merely examining the credit of the borrowers.
3. Tax law changes, or threatened changes, have reduced the tax advantages of real estate public or private partnerships.
The advantage of these real estate partnerships was that accelerated depreciation on their property investments was passed through to the partners. These usually well-to-do investors took large paper losses against their other income, saving tax dollars. But the Tax Reform Act of 1984, notes Consolidated Capital's Mr. Gallen, ``pulled the teeth from those tax shelters.'' The proposed tax reform, says Mr. Von Thaden, would ``sound the death knell'' to real estate public syndications.
REITs cannot pass through special tax advantages. So they must base their operations on economic grounds, says Mr. Coues. In other words, they must choose properties that provide good income and, they hope, capital gains, or select mortgages or construction loans that have sound properties behind them.
For investors, the advantages of buying REIT shares include, beside the high yields of recent years, their liquidity. They are listed on the New York Stock Exchange, the American Stock Exchange, or over-the-counter. Thus shares can be bought and sold like corporate stock.
Under the law, REITs must pay at least 95 percent of their annual earnings to their shareholders in dividends. By doing so, the REITs do not have to pay corporate taxes. At present there are 125 qualified REITs, 14 of them new last year. Another 27 have stated an intent to get Internal Revenue Service approval as a REIT, a process which requires a year of operation.
A currently popular variety of REIT is one which is self-liquidating. Twenty-seven of these have been formed or are in formation. After say 10 years, the REIT will start a process of selling all its properties and distributing the original money and capital gains back to shareholders.
This, these trusts hope, will mean that their share prices will reflect more closely the current value of the properties held by the REIT. In recent years, the shares of many REITs have been priced below the market values of their assets.
However, if a REIT does gradually turn over its properties (they are forbidden to buy and sell in a speculative manner), it will pass on capital gains to its shareholders. In 1984, for example, capital gains accounted for a good chunk of the 27.6 percent average annual yield on the shares of the Wells Fargo REIT, notes vice-president Stephen Huber.
Last year, $1.16 of the total dividend of $2.80 came from capital gains. Chart: REITS turn in strong yields Source: National Association of Real Estate Invest ment Trusts Year Change in Dividend yield** Total yield
price * 1977 10.08% 8.01 18.09% 1978 -8.53 8.43 - 0.10 1979 17.97 10.67 28.64 1980 10.46 9.68 20.14 1981 -0.21 9.48 9.27 1982 17.10 9.97 27.07 1983 14.89 9.62 24.51 1984 3.89 9.20 13.09 *Percent change in REIT price from year end to year end **Annual yield for all dividend-paying REITs included in the REIT share price index. weighted by the market value of each REIT