Investors Buy Real Estate Firms To Beat Poor Returns on CDs

Cash-rich real estate investment trusts take on a larger share of property financing

WHETHER real estate markets are up or down, the buyer with cash can almost always call the shots. Today real estate investment trusts (REITs) have the cash.

In a recession-pummeled, debt-loaded real estate market, these publicly traded real estate companies are finding wide-open investment opportunities to add to their portfolios of properties.

"The REIT market is going to be very active in 1993," says Stanley Perla, a partner with the accounting firm Ernst & Young in New York. REITs are producing "an initial return somewhere between 7.5 and 9 percent, depending on the type of REIT and the management and operating history.... Compare that to a 3 percent certificate of deposit."

From $9.5 billion in 1985, REITs have grown into a $50 billion industry today.

"We easily have the ability to grow five times our current size," says Mark Decker, president of the National Association of Real Estate Investment Trusts in Washington. Big returns forecast

"The larger REITs with consistent records of cash flow and dividend growth have had access to the equity markets," says Elaine Derso, an analyst with Prudential Securities Inc. in New York. They have been taking "the cash and doing spread investing - going after the properties that are in the hands of the foreclosure portfolios of banks, the Resolution Trust Corporation, limited partnerships that need to raise money - and buying at yields that are in the 9, 10, and very often 11 percent range."

Kemper Securities Inc. predicts that through 1994 and into '95, some equity REITs should produce total returns (dividends and capital gains) of 15 to 20 percent per year.

In 1992, $6.45 billion in capital was raised by REITs through initial public offerings and secondary offerings. "We're seeing the evolution of a much more stable real estate capital-formation market," Mr. Decker says.

As one of the few ongoing sources of financing in real estate today, "strong REITs are raising capital at comparatively low cost, building their portfolios, and growing their cash flow," Decker says. "This is an excellent environment for buying real estate."

"A hot area has been REITs that invest in apartment houses," says Prudential's Derso. "There has been very little construction since the tax reform act of 1986."

For investors in multifamily housing, "this is not a bad time to be acquiring well situated apartment units," says Hugh Kelly, an analyst for Landauer Real Estate Counselors. "A lot of these assets could be subject to significant appreciation."

A large part of capital formation for real estate before 1986 was driven by the demand for tax shelters. The 1986 tax laws shifted the motivation away from writeoffs toward investing for income and growth.

REITs fit into the income and growth strategy, Mr. Perla says. Current acquisitions by REITs are generally "cash-flowing properties with low debt."

"It's not smoke and mirrors or related to some tax gimmick," Decker says.

In addition to tax-driven changes, other adjustments are under way in the real estate investment community. "The trend we are seeing is the result of fundamental restructuring and reform of commercial real estate markets and the way capital is formed," Decker says. "In most industrialized countries, from 5 percent to 50 percent of commercial real estate is held by public companies. In the US we have only half of 1 percent."

Institutional investors such as pension-fund, money-market fund, and equity-fund managers are providing 50 to 60 percent of the new money being invested in REITs. The rest comes from traditional small investors.

Interest rates are "one of the driving forces" behind REITs right now, Ernst & Young's Perla says. Even if rates go up, "there will still be an interest in REITs because they also offer the possibility of appreciation." But Perla cautions that the flow of investment "might slow down" if interest rate yields go to 7 percent.

But with low current interest rates and an oppressive regulatory climate still a drag on bank lending, more REITs are likely to appear. So far, "there has been enough market demand to sustain all the offerings that have come out," Perla says.

Kenneth Leventhal & Co. says that much of the new investment is going into equity REITs that own retail and health-care properties.

For those thinking about investing in REITs, Derso advises that the strongest companies share several characteristics. Advice to investors

The REIT should be organized as an integrated unit, with advisers, leasing agents, and property managers all folded into one operating company, rather than each function being performed by a semi-independent firm. Often outside boards of directors help the REIT maintain its focus, she says.

Perla recommends choosing REITs that have strong in-place management and a portfolio that specializes in a particular type of real estate. "That's what investors are looking for," he says.

Though the current investment mood is positive for REITs, Decker says that they will prosper in any climate. "Good quality REITs are always going to have the ability to add value to a property, whether it's in the acquisition/purchase price stage, or in their ability to put the right mix of tenants in a shopping center or to do whatever it takes to grow the rents from a piece of real estate."

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