Investors in the nation's 211 Real Estate Investment Trusts got an unpleasant surprise last year.
Instead of being on an up-elevator, as they had been for two years, they headed for the basement. Some analysts say it's a bargain basement today for individual investors wanting to get into real estate without the means or time to buy and manage properties themselves.
Share prices of these companies that own, operate, and finance income-producing real estate ranging from hotels to office buildings to apartment buildings plunged an average 18 percent in value in 1998.
By contrast, the Standard & Poor's Index of 500 major stocks offered a total positive return last year of 28.7 percent.
"It was an extremely horrible time for REITs," says Paul Reeder, who tracks their performance for SNL Securities, a data-gathering firm in Charlottesville, Va.
But 1999 could be different. Several industry analysts see REITs as a promising investment for those concerned with the high prices of corporate stock.
"We think this is a good place to hide," says James Sullivan, an analyst with Prudential Securities in New York. "The downside is relatively limited. REIT earnings have predictability."
Like some other analysts, Mr. Sullivan sees a potential return this year on REIT shares in the low teens, or possibly more. And by comparison to many corporate stocks, REITs are inexpensive.
"Real-estate companies are very fairly valued," says David Kruth, a portfolio manager with Alliance Capital Management, a New York firm that manages $240 billion in assets, including a mutual fund investing in REITs.
Statistics support turnaround
The ratio of the total price of the stocks in the S&P 500 Index to last year's earnings of these companies is at an extraordinarily high 26. The equivalent ratio for the average REIT is about 9.5.
Further, the average REIT provides investors a return of 7 to 8 percent in dividends.
"That's better than you get in the banks," notes Mr. Reeder, referring to certificates of deposit or the return on savings accounts.
It is also far higher than the 2.5 percent dividend yield from S&P 500 stocks. Or the return from money-market funds.
Moreover, Reeder and other analysts expect most REITs to enjoy an 8 to 10 percent growth in their "funds from operations." The FFO is essentially the income that a REIT gets from its investment in office buildings, hotels, shopping centers, medical centers, apartments, industrial buildings, or other properties.
A REIT's cash flow grows as rents rise, perhaps as scheduled under leases or as leases are renewed at higher rents, .
Combining dividends and FFO growth, analysts forecast returns of 13 to 14 percent in 1999.
Though growing rapidly in assets in recent years, REITs are still small potatoes in the investment world. They own total real-estate assets of about $135 billion. Almost all the Fortune 500 large companies individually have assets far greater than that.
That $135 billion is about 10 percent of all commercial properties suitable for investment in the United States, says Steven Wechsler, president of the National Association of Real Estate Investment Trusts in Washington.
The average REIT has $1.3 billion invested in real estate. The market value of the shares of the average REIT is $688 million. The difference reflects the fact that REITs borrow to finance part of their investments. The average REIT is a modest 40 percent "leveraged," that is, it borrows about 40 percent of the cost of the 100 or so buildings it may own.
If the average REIT sold all its properties today, it could pay off its debts and give to its shareholders the price of their stock or slightly more, says Reeder.
Other signs of financial stability for REIT investments:
* Cash flow is about three times interest payments.
* The credit crunch of last fall put a lid on new buildings that might have been surplus to market needs and thus depressed lease prices.
* When the S&P 500 Index moves up or down, the REIT index moves only about 43 percent in the same direction. The correlation with the bond market is only 11 percent.
REITs vs. real estate
Unlike real estate itself, REIT shares can be sold or bought in a few moments just like stocks in any other company. Because of this "liquidity," REIT shares should be trading at a premium above their net asset value, Reeder maintains. He says a 10 to 20 percent premium is justified.
REITs first made their appearance in the US in 1960. But modern REITs developed under the 1986 tax reform law. It allows a REIT to both invest in real estate and manage property. A REIT must pass through tax-free 95 percent or more of its profits to shareholders. These investors, as usual, are subject to taxes on dividends and any capital gains.