Winds of Change Blowing at MIP

In 1985, the timber giant Weyerhaeuser Co. set up a real estate investment trust named Mortgage Investments Plus, based in Woodland Hills, as part of its expansion into financial services.

Such trusts, known as REITs, sell stock to the public and invest the proceeds in real estate, typically commercial properties. Some investors like REITs because REITs avoid paying federal income tax by distributing 95% of their income to stockholders in the form of dividends.

MIP raised about $90 million from its stock sale and began investing in new office buildings and other commercial properties under development in California. Weyerhaeuser, meanwhile, continued supporting MIP by providing it with administrative and advisory services, and collected a fee for its trouble.

But four years later, it is questionable whether MIP is worth the trouble any longer for Weyerhaeuser. The Tacoma, Wash.-based timber concern earned $564 million last year on sales of $10 billion. But MIP’s fees kicked in a mere $1 million of Weyerhaeuser’s sales. Although MIP is profitable--it earned $4.3 million on revenue of $10.1 million last year--Lawrence W. Farmer, MIP’s president, acknowledged that MIP barely covered Weyerhaeuser’s costs of helping MIP to operate. Farmer added that MIP “has not been real profitable for” Weyerhaeuser.

‘Sharpen Its Focus’

And a big change might be coming for MIP. Weyerhaeuser recently announced that it wants to “sharpen its strategic focus” in the 1990s. Translation: It might stick with forest products and reduce its role in mortgage banking, real estate and other financial services.

For now, Weyerhaeuser’s commitment to MIP is intact, but longer term “it’s hard to comment at this point,” said Don Lange, president of Weyerhaeuser Mortgage, the Weyerhaeuser unit that deals with MIP.

What happens if Weyerhaeuser tires of MIP’s current setup? Weyerhaeuser could cut MIP adrift, perhaps forcing the firm to liquidate its properties. Or Weyerhaeuser might buy out MIP’s stockholders and merge the firm into its own operations.

Weyerhaeuser’s role is important because it does most of MIP’s legwork in real estate transactions, and all of MIP’s officers are Weyerhaeuser employees. If MIP had its own staff today, its overhead costs would be too high and leave little room for profit, Farmer said.

Farmer indicated another potential solution: MIP could survive on its own, with Farmer and other Weyerhaeuser employees becoming employees of MIP. Farmer said that if MIP could find a cost-efficient way of running its business itself, Weyerhaeuser “would not oppose that.”

So Farmer has begun planning on how MIP could generate more business to support its own payroll. Farmer, a 53-year-old ex-Marine, thinks MIP can do that with its new strategy, under which it will reduce its investments in buildings under construction and instead focus on the properties it already has or on buying existing properties.

What’s the difference between old and new buildings? Investing in new developments carries certain risks. Construction could be delayed or MIP and its partners--many of MIP’s projects are joint ventures--could have trouble finding tenants to lease its new buildings. Either would delay MIP’s ability to collect rental income.

Existing Buildings

Existing buildings often are already leased. That lets the owner focus on improving the site--be it changing a building’s landscape, its tenant mix or the terms of the tenants’ leases--to boost rental income and increase the REIT’s return on investment.

If MIP is out on its own, Farmer must do something to boost his company’s appeal to investors. Unless MIP can find a way to increase its stock price, it’s unlikely the trust can return to the market and raise money by issuing more stock. Yet the cash from selling more stock might be the only way MIP can grow faster.

Thus far, MIP’s stock has never climbed back above its initial price of $10 a share in 1985. The stock, which closed Monday at $7.625 a share on the American Stock Exchange, is virtually unchanged so far this year.

“The market wants to see growth in cash flow,” said Rita R. Dominguez, an analyst at Merrill Lynch & Co. “That’s what it will reward. We really don’t see that at MIP.”

Cash Flow

Cash flow is vital because investors pay close attention to a REIT’s dividends, and the dividends are determined by how much cash flow--that is, interest income on its loans, fee income and rental income--a REIT generates each year.

In the mid-1970s, REITs got a bad reputation when, during the recession, many of them collapsed from poor management, bad loans and other maladies that cost investors billions of dollars. When Weyerhaeuser set up MIP in 1985, REITs had begun to come back into favor, in part because tax reform was about to crimp the advantages of other real estate investments.

But MIP’s record hasn’t been the best. In the four years that ended May 31, the average annual total return (stock appreciation plus dividends) for REIT industry stocks was 3.9%, said Christopher Lucas, research director for the National Assn. of Real Estate Investor Trusts, a Washington trade group. But MIP’s average return was a meager 1.6%.

Young Company

To be sure, MIP is still a young company and many of the REITs against which it is compared are older, have bigger portfolios of properties and a history of steady dividend growth. Given more time, MIP also might bolster its results, particularly because it will be able to start selling some of its holdings next year. Under IRS rules, REITs must hold properties at least four years before they sell them, and MIP’s original investments will reach that threshold next year, Farmer said.

In the meantime, Farmer also is moving MIP away from developing office buildings and more toward investments in industrial and regional shopping centers. The latter two are easier to rent and are less time-consuming and costly to build, he said.

So, in addition to being a part-owner of such office complexes as the San Diego Corporate Center and the Ontario Business Center, MIP now has interests in such retail centers as the Sunwest Retail Plaza in San Bernardino and the Mart of Montebello.

With this strategy, Farmer is trying to emulate a successful REIT such as Burnham Pacific Properties in San Diego. Since being converted from a partnership to a REIT in April, 1987, Burnham Pacific has raised $60 million in two stock offerings, raised its dividend eight out the last 10 quarters and has its stock trading 25% above its initial price.

Track Record

To be sure, Burnham Pacific has a much longer track record than MIP. Burnham Pacific is affiliated with John Burnham & Co., a 98-year-old real estate and mortgage services concern in San Diego.

But Louis J. Garday, Burnham Pacific’s president, said his firm has outperformed MIP because it invests in existing properties and then tries to improve those properties and increase the rental income they generate. By contrast, MIP generally earns a fixed return on its money while its new buildings are being developed, he said.

“MIP has some properties I would love to own,” Garday said. “But the stock market doesn’t seem to be as patient with that format.”