Partners, Green Street Advisors Inc.

Real estate investment trusts, commonly called REITs, are hot on Wall Street this year, with $11 billion in such securities expected to be sold by December. While many developers cannot get good prices for their properties on Main Street, packages of properties sold as REITs are dramatically outperforming the S&P; 500. Jon Fosheim, 42, and Mike Kirby, 32, in 1985 started Green Street Advisors, a Newport Beach research firm that tracks REITs for about 90 institutional clients. They spoke to Times correspondent Debora Vrana.

* Why are REITs so hot right now?

KIRBY: You have to ask yourself, what sources of financing did real estate companies once use? They used to look at savings and loans, partnerships and banks. And all of those sources of capital are either defunct or severely limited. It’s not so much that REITs are any better than they used to be, it’s that some of the other vehicles have gone away.

Simply, what is a REIT?

FOSHEIM: The best analogy for a layman is a closed-end mutual fund, of which there are hundreds. In such a fund, money is raised and the investment adviser buys stocks or bonds or both. Sometimes the shares for a closed-end mutual fund trade at a premium to the underlying stock and bonds or at a discount.

REITs are very similar. Money is given to a management team to invest in property; those properties collectively have a value. And at times, like today, the shares of those REITs are trading at a significant premium to what the underlying real estate values are. Other times, like in 1989, they were trading at a big discount.

The stock market in 1989 was making a statement, perhaps, that real estate values were poised to go down. They did. Now, they’re trading at a big premium, the market may be making a prediction that real estate values have bottomed and are poised to go higher.

One banker has said, “Even Rambo couldn’t sell a REIT of Southern California properties.” Given the severity of the real estate downturn here, is there some skittishness on Wall Street about REITs from this region?

KIRBY: I think anything can be sold if priced correctly. The biggest hurdle for Southern California REITs will be to get the owners to price them correctly. Once that recognition is made by the seller, I think there will be numerous Southern California REITs coming public. There are a couple filed right now, and we know there are more in the wings. As a test of the waters, we’re going to have the Irvine Co. do a deal very soon. I think the market will probably spank them for the fact that California is currently in the doldrums, but I don’t think anyone believes that is permanent.

What do you think of the REIT of apartment properties recently announced by the Irvine Co.?

KIRBY: I think any comments would have to be taken as preliminary, because there are still some big blanks to be filled in on the deal. For example, they haven’t spelled out exactly what management incentives are going to be and how much stock management will own. Structurally, they have some challenges ahead of them that most other apartment REITs don’t face. And that is they will be buying land from the Irvine Co. over the course of the next 15 years in non-arm’s-length transactions. It’s going to be a challenge for them to make people satisfied that the conflicts of interest aren’t onerous and that they have a value-added capability. Buying the properties at the appraised value could be a problem, because most REIT chief executives will slap you in the face if you accuse them of buying things at appraised value--they typically buy things at deeply distressed value. So that’s going to be the big challenge for the Irvine Co.

Because developers are so strapped for cash, is there a danger of getting schlocky REITs thrown together by developers just desperate to raise money?

FOSHEIM: We’re already seeing a little of that. The fact that a lot of developers need money is an overblown concern; there’s a saying out there: Don’t go broke, go public. I think we have seen some entrepreneurs, who don’t have enough properties to go public, get together with others and piece together a deal. Typically they don’t have a track record or history.

We had a REIT boom in the 1970s that eventually went bust. Are we going to see that cycle again?

KIRBY: I think while it’s fair to look at history, I think this time it really is different. These are very different companies than what came public in the 1970s and 1980s. Many of those deals were sponsored by an entity whose primary motivation was to capture fees, and the sponsors typically didn’t own any stock in the REIT.

Contrast that with today’s deals where you are seeing the top-tier developers coming public, as opposed to selling just a piece of their empire. Today, you’re looking at the blueblood of the American real estate industry, and they are retaining ownership interests of 30% and 40% of the company.

Now, I’m not going to predict that we are not going to see a drop in REIT prices. If we get into a high-interest-rate environment, REITs will probably go down in price. But there won’t be the type of bust (of the 1970s) due to the poor quality of the companies, at least given what we’ve seen come public so far. Now it may be that if we see a drop-off in the quality, there could be a real blowup.

What’s next for the REIT market? Are we going to see a REIT of office properties?

FOSHEIM: We think the next big frontier for REITs is in what we call the leper area--the office and hotel segments are the leper area of the real estate industry. Lenders won’t touch them. REIT investment bankers say we’ve got our hands full with shopping (centers) and apartments, why try office and hotels, where you have a trend line going down? Let’s wait till we get a bottoming effect. Well, I think we’ve seen a bottoming effect in many parts of the country. This has huge ramifications, because the office market is bigger than any commercial real estate sector, and we haven’t started on the office sector yet.

On a new rule that allows pension funds to own more than 10% of a REIT. . .

FOSHEIM: “The notion that this is a positive is overblown. We don’t know any pension fund that wants to own more than 10% of a REIT. They don’t want all their eggs in one basket.”

On concerns about REITs. . .

KIRBY: “Our hot button is disclosure. It’s understandable that with 26 REIT IPOs this year, you’re going to see varying degrees of disclosure to investors. Some have done a very poor job of communicating to people what they are buying.”

On what to look for in a REIT. . .

KIRBY: “We look at how are the properties, what are they worth? We look at management’s ability to grow the company.”

On the Orange County real estate market. . .

FOSHEIM:”Doesn’t look like we’ve hit bottom yet.”