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Industry�s Staggered, But Not Down
Originally published in Real Estate Forum, 1999
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.�
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