Joseph Dobrian, Occupation published sample

Industry�s Staggered, But Not Down
"What Crisis?" REIT Observers Demand

Originally published in Real Estate Forum, 1999


Reports that the REIT industry is in a state of collapse are considerably exaggerated, although there�s no denying that a few REITs are on unsteady legs nowadays. During a couple of years as Wall Street�s blue-eyed boys, REITs fell victim to the mistake commonly made by people who really ought to know better: assessing a newcomer�s strength based only on its performance when the going is good. When cheap acquisition opportunities dried up, as the real estate market improved, earnings growth slowed, and so did the flow of capital into REITs. That, coupled with various financial crises beyond the control of the REITs, caused REIT stocks to collectively plummet in value in the late summer of 1998.

REITs came back again at the beginning of this year, but then slid back downwards again as the year wore on, and now seem still to be a long way from a recovery. Still, most industry insiders-including some disinterested parties-insist that this is all part of the evolution of the still-young REIT industry: a sort of normalization. Whether that assessment is on target, or just wishful thinking, it does seem to be the majority opinion so far.

�This is a normal situation,� insists Lawrence S. Kaplan, national director of REIT advisory services at the E& Y Kenneth Leventhal Real Estate Group, New York City. �At the beginning of the REIT cycle in 1992, the REIT vehicle was a useful tool to obtain capital. There was little interest in the stock market; real estate was oversold; bargains could be had. That situation changed as property became more expensive, and the lure of buying into REITs became less attractive. This was happening before the 1998 crash.�

The moral of this story, says Kaplan, is that the use of the REIT vehicle solely to raise debt or equity was an aberration caused by the circumstances of the early 1990s.

�Now, things are back to normal, prices are not at bargain levels, and REITs have to be imaginative to find the right type of financing,� he continues. �REITs will do joint ventures, borrow from institutions, make secondary public offerings, etc. The REIT market has fallen through for now, but the real estate market is fine.�

Edward H. Linde, president and CEO of Boston Properties, Boston, agrees that the REIT industry is going through a rough patch, but just needs to stick to business in order to get through it.

�Our current strategies are unchanged,� he reports. �We continue to play our strong suit, creating value through development. We�re bullish about real estate in general. Our company and the whole REIT sector are undervalued, simply because other investment opportunities seem more glamourous than REITs just now.�

Richard S. Curto, president and CEO, Prime Group Realty Trust, Chicago, which owns some 5.5 million sf in downtown Chicago, agrees that the only big problem with REITs today is that they�re undervalued-which presents an opportunity for canny investors.

�REIT stocks have not performed well this year relative to other years,� he admits, �largely because of funds not flowing into smaller-cap stocks. We feel our stock is significantly undervalued: $15.50 a share, while net asset value is about $24 per share. Undervaluation can happen in any industry, and the solution is to continue to run your business day to day, increase FFO [�funds from operations,� analogous to �earnings per share�] and create shareholder value.�

�I don�t buy �crisis,�� states John J. Kriz, managing director for real estate finance at Moody�s Investors Service. �Other industrial sectors are having the same problems. Stock prices go up and down, and you�ll often hear of a company that reports record earnings and yet its stock drops.�

�REITs are not being valued on their underlying assets,� agrees Thomas Lowder, president, chairman and CEO of Birmingham, AL-based Colonial Properties Trust. �Investors can actually buy the stock of a public owner of real estate for less than directly buying that same real estate. The REIT industry size and limited market liquidity have not been positive factors in the stock prices.�

A Question Of What�s �In�?

Why are REIT stock prices low? Are they likely to rise anytime soon? Several industry insiders point to a very simple reason for the depressed prices: REITs are simply not fashionable!

�Real estate stocks are attractive to the �value-style� investor who focuses on valuations relative to historical standards,� explains Kelly Rush, portfolio manager and principal at Capital Management, New York City. �That style of investing, however, is out of favor, and �growth investing� is in favor. During the second half of the decade, the highest return results have typically come from focusing on companies with strong earnings momentum. In 1996 and 1997, when earnings growth for real estate companies was accelerating, capital flowed to the stocks and share prices spiked. As earnings growth started to decelerate to more sustainable levels, momentum-driven investors dumped the stocks. As earnings have continued this pattern of deceleration in 1999, it�s difficult for the group to attract any interest.�

The future holds both good and bad news for REITs, Rush predicts. The good news is that long-term, growth and value styles of investing deliver comparable returns. In time, value-oriented stocks such as REITs will deliver superior returns. The bad news is that it will probably take a significant market decline to cause value-oriented stocks to attract investors.

�Value investing traditionally comes into favor following sizable market corrections, which would likely pull down real estate share prices as well,� Rush points out.

�Growth stocks, today, are clearly performing better than value-oriented stocks,� concurs David J. Nettina, president and COO of SL Green Realty Corp. �Overall, REITs are fairly strong and low-leveraged, but the market has not rewarded them.�

�REITs are out of favor, not for any fundamental real estate reason, but because of alternative investments in the capital marketplace,� remarks Gerard H. Sweeney, president and CEO of Brandywine Realty Trust, Newtown Square, PA. �They should be generating not just current income, but capital appreciation, and over time they will. As investors focus on stability, they�ll come back to REITs.�

Thomas C. Martel, president of Baltimore-based NAI KLNB, agrees that REITs are value stocks, not growth stocks, and must be taken as such.

�REITs do very well on dividends,� he notes. �Right now, smaller investors who look to REITs for income and stability and moderate growth are leaving them in favor of the high tech stocks that offer accelerated growth. In a year or two, though, people will start looking at REITs for the dividends. We just have to wait for the high tech stocks to stabilize.�

Cites Misguided Positioning

Meanwhile, REIT stocks are unloved because they�re misunderstood. Rand Griffin, president and COO of Corporate Office Properties Trust, Columbia, MD, attributes this misunderstanding to �a strategic mistake� that the Washington, DC-based National Association of Real Estate Investment Trusts (NAREIT) and the investment banking community made when they positioned REIT stocks as growth stocks a few years ago.

�They should have been positioned as �return� stocks, like a utility,� Griffin asserts. �Moreover, we�ve not done a good job of getting the retail investor, Joe Average, involved in our business. He�s going to make the difference, and he doesn�t understand REITs, doesn�t know what FFO is, etc. There�s also the perception on the street that if you give real estate people any money, they�ll overbuild.

�We need to educate the individual investor as to what is a REIT, why he should own it as a balance to his portfolio: maybe positioning it as an alternative to utility stocks, which you buy because they�re safe, with a good dividend return, but only a little growth. A REIT is not a stock like Coca-Cola, or Gillette, which is low dividend/high growth, and is more cyclical.�

REITs, Griffin insists, should produce a higher yield than a utility, and good stability. Most REIT portfolios are highly leased, well managed, not too leveraged.

�You should see a transfer of utility investors-utilities are facing deregulation and the uncertainty thereof-into REITs,� he concludes. �Utilities now are freezing or slashing dividends, re-forming and coming back. We need to capture the uncertain investors. Some investors say, �If REIT stocks are down, now that things are good, what will happen when things are bad?� But we need to show that there�s lots of potential even in a down-cycle, that REIT stocks are more recession-proof than most industries. REITs are getting hammered in the market because of misperceptions.�

�And nobody seems to know how to assign value to REITs,� adds Randy L. Churchey, senior vice president and CFO of Dallas-based FelCor Lodging Trust. �You�d think that a company that�s liquid would trade at a higher multiple than one that isn�t, but that�s not happening today. You�d think a full service hotel REIT, like ours, would trade at a higher multiple than a low-service hotel REIT, but that�s not happening either.�

John E. Garippa, partner in the law firm of Garippa & Davenport, Montclair, NJ, notes that REIT stocks are suffering as the result of merciless property tax assessments against assets purchased by REITs.

�There appears to be one abiding maxim that all taxing jurisdictions embrace: �Every high sale is a market value sale, and every low sale is a distress sale,� he notes. �For several years, REITs have bought properties at prices far above perceived market value. Now, in 1999, taxing jurisdictions are embracing these sales as �market value� transactions, and assessing taxes accordingly.�

Since REITs must distribute 95% of their income, Garippa explains, they cannot have retained earnings; thus, they are only able to grow through acquisition of more property. The only way for a REIT stock to grow is for the portfolio to expand. The only way the portfolio can expand is by greater acquisitions of properties. This scenario created strong demand for properties and, therefore, higher prices in the marketplace. The high prices lead to high taxes, which cut into the FFO.

�Those of us who labor in the trenches must effectively lay out the argument that these abnormal sale conditions are not reflective of typical �market� transactions,� he insists. �As such, they should not be relied upon to set market value for property assessment purposes. This will be a difficult but critical fight in the long term health of the REIT industry.�

Certain types of REIT stocks are performing better than others, of course. Charles W. Wolcott, president and CEO of American Industrial Properties, Irving, TX, says those that specialize in industrial/office flex space seem to be best positioned. There�s been relatively little industrial construction lately, and industrial companies will benefit from e-commerce distribution.

�About 60% of revenues from our properties come from high-tech companies: providers of computer software and hardware, simulations, virtual reality, telecommunications, e-commerce and Internet,� he estimates. �As long as that sector stays healthy we�ll see improving income.�

Apartment REITs comprise another healthy category, says Georgia J. Malone, attorney and real estate consultant who finds acquirable properties for REITs. The best of those, she predicts, will produce a 13% return this year, of which about half will come from dividends, and half from growth of the business.

�A year ago,� she admits, �REITs were off 18% because people were fearful of overbuilding, but these fears were unfounded, as were fears of recession. Fundamentals are still good, the economy is healthy, and REITs are not overleveraged. Most are at 50% LTV, which is not much.�

Debt Debate: How Much Is Too Much?

The issue of leverage has been scaring a lot of investors away from the REIT market, many experts agree-but they also agree that REITs are not overleveraged, and that many investors have an exaggerated fear of putting money into a company that�s in debt.

�Compared to privately held real estate, that owned through REITs is very conservatively leveraged,� claims Steven A. Wechsler, president and CEO of NAREIT. �The outlook for debt/equity ratios in the coming year continues to be positive. The discipline of the public marketplace will ensure that REITs are conservatively financed. Companies may look for different ways to utilize the debt and equity markets, but they'll do so in a balanced manner.�

Even REITs that many people would consider highly leveraged, are not, compared to private owners of real estate. Rand Griffin, president and coo of Corporate Office Properties Trust, Columbia, MD, points out that while his is one of the most debt-driven REITs in the country, its debt/equity ratio is still only about 55/45.

�We differ in our capital strategy,� he explains. �We�re more leveraged than the average REIT, and some people say that�s a problem, but it�s not, because we�re over 98% occupied, renewing 90% of the leases that come up for rollover, getting significant rent increases, and renting mainly to investment-grade companies that sign for an average of six years. Debt is cheaper than equity, and REITs that are two-thirds equity are finding that it�s not a cost-effective way of doing business.�

Corporate Office Properties is non-rated, by choice, Griffin says.

�Many REITs can�t raise enough debt, because of their rated status,� he notes. �If they raised more debt their ratings would be in jeopardy, and they can�t go to the market and issue equity. They�re trying to be self-sufficient, raising capital only by selling or by joint ventures, not moving the company ahead. We, on the other hand, have tripled our portfolio in 18 months. We�ve had a 70% increase in our FFO per share in that time.�

Not everyone agrees with Griffin�s strategy.

�He�s right that debt is cheaper than equity,� admits Randy Churchey. �But if you�re highly leveraged, you might find it hard to jump in if a new opportunity arises. And if, all of a sudden, everything goes wrong-as it sometimes does-how will you pay off your debts?�

Lawrence Kaplan seems to think that success or failure won�t be based on how much debt a REIT has, but on the ability of its managers to lead.

�The most successful REITs will have extremely competent management teams that understand not just real estate, but the capital markets, that understand what it means to run a public company,� he says.

Strong management is vital, Georgia Malone agrees; she also predicts that REITs that are intelligently diversified will come out on top.

�Three REITs that I think are best for the long haul are Boston Properties, Aimco, and Simon Properties Co.,� she states. �Boston has excellent investments in 24-hour cities like Boston, San Francisco and New York. Aimco is a hit because it�s a well-diversified, well-managed specialist in Class B apartments, for which there will always be high demand. Simon Properties is the country�s largest shopping center REIT, with an exceptionally deep, experienced management team.�

Mitchell Hersh, CEO of Dallas-based Mack-Cali Realty Corp., also points to diversification as a key factor.

�The REITs best positioned for the long haul are not specific to property type or region,� he contends. �REITs that operate with a significant presence in diverse markets offer a hedge against downturns in any particular local or regional economy.�

Beyond that, says Hersh, he expects strong performance from REITs that get a large portion of their earnings stream from markets that have a high barrier to entry.

Diversification is a cornerstone of Chicago-based First Industrial Realty Trust�s long-term strategy, concurs president and CEO Michael W. Brennan.

�Our plan is to focus strictly on industrial property, on a nationwide basis, using local operators,� he reveals. �A pure industrial focus puts our company in the most stable and least consolidated sector, a sector that comprises 20 billion sf nationally. We�re diversified geographically-we�re in about 33 markets-and we�re diversified as to tenant type, with none of our 3,000 tenants responsible for more than one percent of our total revenue.�

But while industrial REITs seem strong, on the whole, and office and apartment REITs seem likely to bear up well, retail REITs are finding the going pretty rocky, says Robert J. Hellman, managing director of Newmark Retail Restructuring LLC, an Affiliate of Newmark & Company Real Estate, New York City.

�In the retail environment, certain REITs will continue to struggle to increase shareholder value in the near term,� he predicts. �Although REITs that own dominant centers in their respective markets have shown enduring strength, there have been minimal rent increases at some centers as a result of over-storing and greater commoditization of product.�

Agreeing with Hellman is a report by LaSalle Investment Management, �Second Quarter 1999 Review and Outlook for the U.S. Real Estate Securities Market.� Long-term, the report warns, retail REITs will continue to battle the propensity of retailers to overbuild, and the competitive pressure from Internet-based retailing. The report further states that while office, apartment and industrial markets seem to be in a healthy equilibrium, the hotel industry might be slowing.

Re-Form, Re-Group, Buddy Up!

With many REITs finding it difficult to create shareholder value doing business as usual, many observers expect to see considerable re-shaping of the industry. Consolidation, through mergers and acquisitions, is likely over the next few years. Joint ventures with private investors are gaining popularity.

�Capital isn�t coming from REITs increasing their leverage; it�s coming mainly from joint ventures,� Lawrence Kaplan observes. �Investors want to do a specific deal on a specific property, not lend into the REIT. Investors like pension funds prefer development projects into which they�ll get a preferred return, as partner, not as lender, which means the analyst won�t look at the new partner as a creditor, and won�t ding the REIT for having ratcheted up its debt level.�

The preferred return makes the joint venture partner almost like a creditor, Kaplan explains, but the terms are looser because it�s an equity investment. REITs benefit in two critical ways from such a setup: they put up 20% of the capital, but as managing partner probably get more than 20% of the profits. Also, they can earn fees by providing services to the partnership, while the partner pays half those fees.

�Some joint ventures are being done in the form of REITs themselves,� Kaplan adds. �They�ll form a new REIT in which the REIT and the partner are shareholders. This is helpful to some foreign investors because it gives them tax benefits, and assures them of corporate government, rather than a partnership, which makes some investors queasy.�

�The joint venture technique by which a REIT can invest in a minority position in a property, or a portfolio of properties, while retaining management responsibility, can be employed either for assets within a REIT�s existing portfolio, or for new acquisitions,� notes Russell L. Appel, president of New York City-based The Praedium Group.

�Since joint ventures are off-balance-sheet transactions, some REITs may take on more leverage, or engage in more opportunistic deals, or deals that are farther out in the risk spectrum, in an effort to boost returns,� suggests Susan Cheung, REIT securities portfolio manager at L&B; Realty Advisors, Dallas. �However, the fact that these are off-balance-sheet can be unsettling for investors, since it makes the financial structure of the company rather more opaque.�

Joint ventures aren�t always the answer. James M. Steuterman, executive vice president and COO of New Plan Excel Realty Trust, Inc., New York City, insists that they only work for low- or unrated companies.

�If your debt is highly rated, don�t do joint ventures,� he admonishes. �Rating agencies look right through a joint venture strategy, and they ascribe to the REIT the full effect of that joint venture debt, even if a REIT is responsible for only 10% of it. If you�re not rated, of course, you don�t care about that.�

�Joint ventures won�t be limited to public companies,� states Doug J. McEachern, western regional director of real estate, and national REIT director, at the Los Angeles office of Deloitte & Touche. �Pension and other funds will provide capital for some development activity, for both public and private REITs. Everyone�s looking for yields and returns, but REITs are also concerned about creating additional cash flow for their operations, and the drag on earnings that would take place in the development stage of the large product would be a burden for a smaller REIT.�

�We�ll see mergers; we�ll see significant stock buybacks,� NAREIT�s Wechsler predicts. �In some cases, management may conclude that liquidation is the best course. When the market sees a combination of these steps, it should respond, and REIT prices will better reflect values on the private side.�

�I think we�re a potential consolidator, or acquirer,� says Boston Properties� Edward Linde, �but any talk about that would be highly speculative at this point. There�s going to be more talk than action about consolidation. We�re not going to acquire, or do anything else, just to drive our stock price up.�

Still, REIT stock prices have got to go up eventually, or go out of the public market, and shareholder value is often created by consolidation. Thomas P. D�Arcy, chairman and CEO of Bradley Real Estate, Northbrook, IL, insists that over time, the market will realize that REITs with strong fundamentals are a good investment, but he admits that there�s much talk of mergers and buyouts.

�But you hear that in any bear market,� he adds. �Fundamentals are healthy, with solid occupancies and cash flows. Our portfolio is performing well, but our share price is not performing well, so we try to create value for the shareholder by focusing on internals.�

It�s A Sell Cycle-But What To Sell?

�Focusing on internals� often involves getting rid of non-core assets that have become burdensome or that have reached a prime selling point. Today, most REITs are in a �sell� cycle, but most observers consider this a normal, desirable adjustment. Bruce G. Wiles, president of MeriStar Hospitality Corp., Washington, DC, says the best value creation he can employ is to reduce MeriStar�s asset base through the sale of non-strategic assets, and using the proceeds to buy back stock.

�I haven�t seen an investment opportunity that could match that yield,� he declares.

An opposite type of transaction, the stock-for-property deal, makes less sense to Wiles.

�Our shareholders would throw vegetables, or worse, at us if we did that,� he says.�

Colonial�s Thomas Lowder agrees-with a proviso. �Stock-for-property transactions make little sense in today�s environment because of depressed stock values,� he explains, �unless the transaction is structured to recognize the underlying value of the stock.�

Insiders warn that REITs had better be careful about which assets they sell off. James Steuterman contends that while selling in itself is not a bad idea, some REITs are following a counterproductive strategy.

�Typically, you�ll want to sell the most undesirable assets first: the physically sad, the obsolete-but that is the wrong strategy in this cycle,� he elaborates. �Instead, sell those that have been maximized by aggressive management, or those that are financeable, because they�re more attractive. The properties that are not what you�re about-like a retail asset owned by an office REIT-should be sold. Opportunity properties-properties where a tenant wants to buy, for instance-should be sold. Sell the assets that the staff doesn�t want to work on. As for buying, I don�t like distressed properties; I like distressed sellers. Trouble is, right now there are not many of the latter.�

Steuterman adds that he�d expected a slowdown in acquisitions, and was ready for it all along.

�When we saw that the acquisition window was going to begin to close, we started focusing on property management, on redeveloping the assets, improving cash flows,� he says. �Experts forecast we�d do $400 million worth of acquisition last year; instead we did only $136 million-and exceeded the analysts� predicted FFO through asset management. We�ve had tremendous growth in internal leasing and occupancy.�

Now�s the time for REITs in general to be more selective in acquisitions, Steuterman urges.

�Today�s is a low-interest environment,� he points out. �A private investor can get a very high LTV, and conduits will overlook a few wild hairs on a transaction.

�Take for example a $10 million investment, with a $1 million cash flow free and clear: a 10% yield. Joe Average places 85% debt on that transaction. Take an eight percent interest rate as a constant, and from that cash flow you get a 21% yield on the $1.5 million of equity. So, Joe Average has got $680,000 of interest/debt service, and $320,000 returning on his equity. Your REIT, today, buys the same property, but at 50/50 debt to equity: his yield is 12% on the same asset. So, who can pay more for that property today? Not REITs!�

Doug McEachern, too, has his doubts about which REITs are following a sound buy/sell strategy.

�Are REITs selling the good assets and retaining the weaker performers, or vice versa?� he asks. �It�s important to sell the assets that don�t fit into where you want to be: for example, assets in an outlying area, away from your geographical concentration.

�Instead of acquiring, you see a lot of situations where REITs are looking to drive FFO by reducing costs-by contracting a national carpet supplier, or setting up a money-saving electric contract.�

Finding the ideal buyer is a growing challenge nowadays, as communications technology has made it possible for a seller to contact virtually every investor in the world. Wayne J. Delfino, Chicago-based senior vice president and managing director of the Corporate Services Group of NAI, insists that maximum use of Internet-based technology is essential to a REITs success.

�Many REITs, although educated and experienced in the art of acquiring property, lack a system to identify the best buyer,� he warns. �Disposing of a property is too often a matter of engaging a local broker to find a buyer from a short list of active prospects. The local broker, though, may not be able to develop a disposition strategy that has access to a variety of capital sources, including 1031 buyers and offshore capital.

�Thus, one tool growing in popularity is international broad-based marketing. Broad-based marketing firms maintain a database of thousands of active buyers, all available at the click of a mouse. Since broad-based marketing firms utilize strong local broker participation, the concept is acceptable to REITs that worry that awarding dispositions to another firm will curtail future deal flow.�

The Money�s There-If You Can Afford It

Finding a broad base of potential buyers is particularly crucial now that selling non-core assets has become one of the best and cheapest ways for REITs to raise capital. Capital is plentiful enough these days, from the private side, but it�s expensive.

�Two years ago, capital was readily available and relatively inexpensive; today the environment has changed dramatically,� reports Matthew A. Troxell, Director of AEW Real Estate Securities, AEW Capital Management, Boston. �Both Treasury rates and REIT spreads, particularly in the public unsecured market, have increased since the beginning of 1998. In our shop, we have had net inflows into the institutional accounts we manage-unlike most REIT mutual funds, which have experienced significant redemptions-but for the most part we are buying in the secondary market rather than providing new capital to companies.�

�Plenty of money is available,� testifies William E. Hughes, senior vice president of Marcus & Millichap Capital Corp., Newport Beach, CA. �The question is one of cost and whether or not the cost is such that REITs can use it to their advantage considering their current leverage position. Taking a snapshot today [October, 1999], you see that life insurance companies� general account funds are typically dried up for this year, although a few big players have money available yet. In terms of product, most originators of commercial loans are thinking about exit strategies, so they're looking at underwriting and closing on the premise that the loan may at some point be securitized. While all those players are in the market, they don't have the flexibility they used to have. A REIT, which needs flexibility in changing the amount of debt in its portfolio, might have a problem with this.�

That said, Hughes asserts, from the financing standpoint, there's no crisis in the REIT industry.

�Money's available,� he concludes. �REITs will use fixed and flexible rate financing and the balance sheet, and all those in combination will get them through.�

Will We See A Metamorphosis?

REITs might well �get through,� but will they look the same, or will they emerge from this winter�s chrysalis in a whole new form?

�Whatever happens, you won�t see REITs standing pat in the next year,� Rand Griffin adds. �We did that in �98 and we were shell-shocked; we waited for �99, and in mid-�99 the market ramped up, but then lately it�s gone back down to worse than where we were at the beginning of the year. REITs are rapidly reaching a point of frustration. You�ll either see consolidations accelerate, or you�ll see liquidations. Or you�ll see REITs going private.�

Few other industry insiders expect to see privatization of REITs, at least on any great scale. While some people have maintained that real estate was never meant to be securitized, the majority seems to feel that the benefits of a public corporate platform outweigh the hazards.

�Securitization is an idea whose time has come,� says John Kriz of Moody�s. �For one thing, it gives you a positive attitude, forcing you to operate in a transparent manner, in a disciplined manner; it requires you to put together a substantial organization with a definite life to it. In a public company, you need to take an extremely long view. It�s beguiling to report to yourself, but it�s not the optimal way, necessarily, to create value in real estate.�

�The public market environment is still an efficient way of financing real estate,� says Sweeney of Brandywine. �We�ll see more evolution of the REIT model, than abandonment. We�ll see a relaxation of the distribution rules; expansion of the activities REITs can become involved in; the use of taxable subsidiaries to help REITs act as full-service operations. We�re in an evolutionary stage.�

Charles Wolcott, on the other hand, expects to see considerable privatization in the future.

�As long as there�s greater liquidity in the private market than in the securitized market, the process of public companies going private will continue,� he declares. �Over the long term, commercial property markets will continue to be securitized, but the process will be cyclical, based on whether the private or public sectors are perceived as having the greater liquidity. The market favors the private sector today, but in next several years you will see capital going into the public companies. Real estate markets are still largely private; the public market is still relatively small. The process of public markets continuing to grow will occur in cycles, not in a straight line.�

�There�s no need for REITs to reinvent themselves,� Wechsler of NAREIT argues. �Instead, REITs need to stick with the program, which is owning and operating income-producing real estate in an efficient and opportunity-oriented manner. In some cases, this will include development or redevelopment; in other cases, not. The long-term REIT story reflects income on a repetitive basis, with potential for long-term growth.�

Wechsler says he�s hopeful that the REIT Modernization Act-which among other things would authorize the use of taxable REIT subsidiaries-will be passed by Congress this year or next.

�Such legislation will ensure that REITs remain competitive, enabling them to provide their customers a range of services that others in the real estate business will also be providing as the industry evolves,� he adds. �These include cutting-edge telecommunications-related services.�

�Up to now, REIT income had to be derived purely from rental income,� David Nettina elaborates. �The pending legislation will let REITs provide a range of value-added services. We have pursued revenue rulings that approved a program that lets us provide telecommunications to our tenants. That�s not the core of our earnings stream, but it�s an important complement to it.�

�We�re currently providing ancillary services to our tenants within IRS guidelines,� says Richard Curto, �and we�ll expand those services to add value to our tenants and enhance the income of the company. We�ll offer more data and voice transmission; a major conci�rge program that can be accessed by our website; and corporate real estate advisory services.�

�You�ll see residential REITs offering all kinds of ancillary services,� adds Georgia Malone. �Cable TV, computer hookups, and even dog-walking will be standard.�

�The REIT Modernization Act won�t pass on its own, though� Lawrence Kaplan warns. �If any significant tax legislation is passed, the REIT Modernization Act will probably pass, but it needs to be tied to another piece of legislation.�

Whatever legislation is or is not passed, and whether the real estate market improves, worsens or stays the same-REITs are pretty certainly a permanent part of the game, and increasingly important players, at that.

�The only crisis in the REIT industry,� avers Brandywine�s Sweeney, �is the sector�s being out of favor and having net outflow. This is cause for grave concern, but the cycle will reverse itself. There�s a lot of talent in the sector and we�re all being battle-tested, now. It�s a painful ordeal but a necessary part of the evolution of the business.�


copyright 1999 by Joseph Dobrian


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