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REIT Investment Picture Called Sweeter Than It Looks

Bargains Are Out There, One Advisor Says

March 10, 1998|MELINDA FULMER | SPECIAL TO THE TIMES

After years of eye-popping expansion, the real estate investment trust industry is going through some growing pains. Returns have dipped this year. Some stocks have taken a beating over concerns their managers paid too much for investment properties. Congress is prepared to rein in the tax advantages of certain so-called "paired-share" REITs. And after several lukewarm secondary offerings, rumors about a major industry shakeout keep surfacing.

But investors shouldn't let this turbulence spook them, says REIT expert Jon Fosheim of Newport Beach-based Green Street Advisors.

First, Fosheim said, only four of the nation's 213 REITs will be affected by President Clinton's new legislative proposal to scale back advantages for paired-share companies. And second, despite the high prices being paid for glitzy buildings and the corresponding dip in total returns, REIT earnings yields are still far outpacing other mid-cap companies in the broader market.

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Moreover, he said, despite many mergers and acquisitions, the real estate investment trust ranks aren't yet shrinking. The number of initial public offerings far outweighs the number of smaller REITs being consumed.

"For every company being merged out, there are two being formed," Fosheim said, including new issues that will likely be formed from the real estate assets of such blue-chip operating companies as McDonald's Corp.

The oft-predicted REIT consolidation will only start taking place in earnest when the country's booming real estate markets reach their peak and start slowing down, he said. That could be several years away.

Fosheim said foresighted individuals who buy into struggling companies with attractive assets will realize big returns when they are paid a premium for their shares by the powerhouse acquiring companies.

But to find bargains such as these, most individuals will either have to be clairvoyant or have the scoop about a company's acquisitions or its strategy, he said. There is a dearth of public information for most individual investors to use to evaluate the bewildering spectrum of REITs, save for quarterly reports and tables charting the stock price.

And those two factors don't tell the whole story, Fosheim and other analysts say.

"By focusing on funds from operations, there is always going to be a bias toward companies that buy junk properties and companies that use variable-rate debt to finance acquisitions," Fosheim said.

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In other words, some companies' smart-looking acquisitions may not be able to pay for themselves in the future. And rising interest rates may put the squeeze on earnings.

"Don't look at cash flow and cash flow growth or dividend yields, look at what the underlying values of the assets are and go from there," Fosheim said. His research firm looks at the net asset value of each firm's real estate and adds a premium for elements such as growth, a good management team, low corporate overhead and high insider ownership.

But how much these other factors are worth is a little tricky for most individual investors to calculate. Many investors who take it upon themselves to invest in individual stocks, rather than a real estate mutual fund, make costly mistakes, he said.

One of the biggest and most common errors in judgment is assuming that a front-page article on changing economic conditions can lead to an opportunity overlooked by the rest of the market. For instance, Fosheim said, if there's a major newspaper story about apartment overbuilding in a certain area of the country, there's a good chance that Wall Street has already caught on and prices have fallen.

"Do some homework and find a no-load [real estate] mutual fund and put your money with a pro," Fosheim advised.

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