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COMMERCIAL REAL ESTATE

REITs Recovering Former Luster as Investments

But analysts equate them with bonds and utilities and wonder if higher interest rates might end the rally.

May 25, 1999|BOB HOWARD | SPECIAL TO THE TIMES

Real estate investment trusts, darlings of the investment world in 1996 and 1997 before they fell from favor and their stock prices tumbled last year, are making their way back into the good graces of many analysts and investors.

But just as REITs revive, the Federal Reserve is hinting that it might raise interest rates later this year, prompting analysts to wonder if the month-old REIT rally will last.

Interest rates raise concern because today's REITs behave more like bonds or utilities than the highflying growth stocks they were promoted as a couple of years ago, analysts say. If interest rates jump, bonds might offer significantly higher returns than REITs, so investors might switch some funds out of REITs and into bonds.

"REITs have a bond-like quality to them, in terms of valuation, so if interest rates would spike and bond values drop, some of that would spill into the REIT sector," said Jim Sullivan, an analyst with Green Street Advisors in Newport Beach.

Nonetheless, Sullivan views today's relatively low prices of publicly held REIT stocks as something of a puzzlement.

"The average REIT in the universe of 75 companies that we track is trading at about an 11% discount to net asset value," Sullivan said. "When you look at the real estate markets and most property types in most parts of the country, it's hard to understand why the average company would be trading at a discount."

"You can think of REITs as growth utilities without the government regulation," said Craig Silvers, an analyst with Sutro & Co. in Los Angeles.

Silvers said Sutro views REIT stocks as "very attractively" valued, based on their dividend yields as well as their price-to-earnings multiples. REITs generally are paying higher dividends than the broader stock market, Silvers explained, while their lower price-to-earnings multiples suggest potential for their stock prices to rise.

"There's a big disparity between Wall Street and Main Street," Silvers said. "If some of the REITs went private, their stock would probably fetch 20% more than [they are] valued in the public markets. We think most REITs are from 5% to 20% below their private market value."

Today's take on REITs is that they were only temporarily suited for their role as growth stocks. They enjoyed a brief window of opportunity to buy properties at low prices right after the recession, reaping quick, steep profits when those properties rose in value. With property prices much higher today, REITs have to work harder for profits and must demonstrate that they can manage properties profitably.

REITs started returning to favor last month, in part because of investor Warren Buffett's disclosure that he bought about $50 million worth of REIT stocks, Silvers said. But he believes they were due for a slow resurgence even without Buffett's boost.

"People are looking at REITs as a good, safe investment," said Victor Coleman, president and chief operating officer of Brentwood-based Arden Realty Inc., which owns and manages 18 million square feet of office buildings in Southern California. Arden, one of the most active buyers during the REIT acquisition spree in the mid-1990s, is Southern California's biggest office landlord.

"In real estate, unless you're buying assets, which is the glory part of the business, you're not on the front page," Coleman said.

But REITs in general and Arden in particular have remained very active despite their slower pace of acquisitions and lower media profile, Coleman said. Arden has continued its acquisitions, albeit on a smaller scale, and is developing a number of new or rehabilitated properties.

Among its premier projects are the new Howard Hughes Center, a 70-acre development along the San Diego Freeway just east of Sepulveda Boulevard, and the renovation of Westwood Center, a 313,000-square-foot office building in the heart of Westwood.

At Howard Hughes Center, the company began construction late last year on a 240,000-square-foot speculative office building scheduled to be completed early next year. It is the first phase of a project that is slated ultimately to include 2.5 million square feet of office, industrial, retail, entertainment and hotel space.

At Westwood Center, Arden is completely renovating a building that suffered from a 60% vacancy rate, "undistinguished architecture, dated systems and a poor overall image," according to the company's annual report. The building is targeted for completion at the end of this year.

Arden, which has 4,000 tenants in its 18 million square feet of space, completed 905 lease transactions on 4.2 million square feet of space last year, Coleman added, noting that the company is getting higher rents in virtually every new or renewed lease.

Like Coleman, Chief Executive Kenneth B. Roath of Newport Beach-based Health Care Property Investors Inc. pointed out that REITs haven't exactly been standing still.

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