The New REIT: Smarter, More Selective?
Now that real estate investment trusts have helped to reshape the commercial property landscape, the big question being asked in industry circles is: What’s next for REITs?
Will these darlings of the 1990s real estate recovery continue their buying binge, driving prices ever higher for office and industrial buildings, shopping centers, apartment complexes and other investments until they run out of properties to buy?
Having thus exhausted their capacity to grow through acquisitions, will the REITs then turn to developing their own projects as a way to keep feeding Wall Street’s insatiable appetite for growth?
And, having turned to development, will REITs become guilty of the same overzealous overbuilding that marked the previous real estate cycle?
For some time now, conventional wisdom has said that REITs will indeed buy all the good properties and eventually turn to development in order to keep growing. Conventional wisdom has also said that REITs won’t fall victim to 1980s-style excess because Wall Street money is smarter than the savings-and-loan money and foreign investors who fueled the last overbuilding boom.
At least one of those who has been leading the REIT charge disputes much of that conventional wisdom.
Richard Ziman, chairman and chief executive of West Los Angeles-based Arden Realty Inc., believes REITs are a long way from running out of properties to buy, though he says Arden and others must be more selective in future acquisitions because fast-rising prices have reduced the returns on investments.
“I think we’re going to see the Japanese finally begin to unload their holdings, especially with the favorable exchange rate between the yen and the dollar,” Ziman said. He said those properties, along with holdings that he expects Indonesian investors to liquidate, will make more high-quality properties available for REITs to buy.
“More Class A and A-minus properties will be available,” the chairman said. “Everybody seems to think the Japanese bought only trophy properties, but they also bought a lot of next-tier properties. Many of these will be on the market and will represent acquisition opportunities.”
On the other hand, REITs aren’t going to snap up the properties just because they’re available, Ziman said. They’re already becoming more selective in their acquisitions in order to maintain desirable returns.
“I think, for the first time, we’re seeing serious resistance” to the rising prices, Ziman said. “The REITs have drawn the line.”
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It was only a matter of time until the REITs drew that line, according to Paul Prescott, a partner in the Arthur Andersen Real Estate Services Group in Los Angeles.
“The REITs still have a big appetite for properties, but there just aren’t as many good deals as there were,” Prescott said. “I don’t think they’re going to pay a price that doesn’t fit into their overall strategy.”
Sliding stock prices may also be slowing the REITs’ zeal to buy, Prescott said.
“Any volatility in their stock prices has an impact on their ability to use equity instead of cash to buy properties,” Prescott said. “As sellers perceive that there is more risk in REIT stocks, there may be a cash price and there may be a different, higher price the seller asks for in an equity deal.”
Ziman also disputes another tenet of the conventional wisdom: that REITs must grow through “external” activities, such as acquiring properties or development.
“REITs now have a tremendous potential for internal growth, especially in Southern California, where there is great growth in rental rates and absorption. The internal growth in the future is going to be greater than the external growth, which is the reverse of what we’ve seen the past few years,” Ziman said.
Ziman’s belief that REITs can grow internally was reflected in Arden’s latest quarterly financial report, filed May 15, which said Arden expects to grow through “active management of the company’s existing portfolio” as well as “through strategic acquisitions and through development of new office or R&D;/industrial properties.”
It was no accident that the financial report listed internal growth first, acquisitions second and development third, Ziman said. He believes Arden’s biggest growth will occur internally, acquisitions will become a secondary means of growth, and development will run a distant third.
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“About 18 months ago, we [held] about 4 million square feet. Now we’re at 18 million. We’ve achieved certain of our objectives, so now we want to concentrate on increasing our efficiencies and reducing expenses,” Ziman said. “Development is part of the overall program, but far and away the biggest part of our growth is going to come internally.”
Financial analyst Jay Leupp of BancAmerica Robertson Stephens in San Francisco is also counting on substantial internal growth at Arden, according to a June 11 announcement by Leupp that he was initiating coverage on the REIT.
Leupp pointed out that 40% of Arden’s leases expire over the next three years, and he expects these leases to be renewed at 10% to 20% above current rental rates.
In terms of external growth, Ziman said Arden will pursue a course that differs from the “Class A buildings only” strategy that is so often attributed to REITs.
The company is still interested in quality buildings, but Ziman said it is also targeting what he called “aging desperadoes in good locations.” The plan is to “renovate, modernize and reintroduce these buildings to the marketplace,” he said.
Ziman’s outlook does mirror the conventional wisdom in one sense: He says that when REITs do turn to development, they are likely to do so more wisely than their pre-crash predecessors.
“REITs have to develop selectively and at opportune times, when rental rates justify new construction,” he said, or else they will risk the overbuilding that sank so many developers in the 1980s.
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While Ziman cites prudence as the reason to avoid overdevelopment, REIT expert Prescott said there’s also a provision in the laws governing REITs that is likely to prevent them from building foolishly.
“There are some restrictions that prevent REITs from developing buildings for sale,” Prescott said. “The provisions of the law are complicated, but in general, a REIT must hold a property for four years and meet some other tests before it can sell and still retain its REIT status for tax purposes.”
Prescott said he believes that as REITs turn to development, they will look only at projects that make financial sense.
“I don’t share the fear that we’re going to have a repeat of the previous cycle, at least not from the REIT sector,” he said.
Some REITs are already showing restraint in not developing, according to Vincent Pellerito, a senior broker with Cushman Realty Corp. in West Los Angeles.
Pellerito said he represents a client who was approached by a REIT looking for a prospective anchor tenant for a new office building the REIT was considering developing on a site it owns. But the REIT chose not to build when its financial analysis showed it would have to charge 20% to 40% more than current rental rates in order to achieve its required return on investment.
Overall, according to Pellerito, the pace of REIT activity in general seems to be tapering off.
“Last year at this time it was a frenzy,” he said. “The REITs are still active, but the pace seems to have slowed down. I think the market is strong, but I don’t think it is as strong as some people say it is.”
That slowing may be reflected in the prices of REIT shares, which are down about 10% this year. The average REIT mutual fund lost 6.9% in the quarter through Friday, one of the worst performances among domestic stock fund categories. Year-to-date, the average REIT fund is down 7.2%.
Conventional wisdom has been less certain about REIT stock prices than it has been about other facets of their future. Opinion varies so widely on Wall Street that some investment experts consider REIT shares an undervalued bargain while others consider them risky and overpriced.
Prescott said part of the problem is that “REITs are difficult to understand and may seem to defy a rational explanation if you’re trying to do a traditional stock analysis.” Despite their slide this year, he pointed out, REIT stocks have actually outperformed the market over the last five years.
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Real estate generally runs counter to the stock market, so many investors traditionally have considered property investments a hedge against stock market investments. But in the case of REITs, he said, there’s insufficient history to indicate whether they’ll behave more like real estate or more like the stock market.
“I don’t think anyone knows for sure yet if REITs are a hedge investment or a growth investment,” he said.
But one thing is certain, Prescott said: REITs bear watching because they are part of a continuing shift in property ownership from private hands to public entities. As such they will continue to play a major part in the ongoing transition of the real estate industry.
* TOP FUNDS: Morningstar rates top real estate funds. D13
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The REIT Race
The following REITs are based in Southern California. The chart shows their closing prices as of June 26, their low and high share prices over the last year and their yield per share.
Southern California REITs: Alexander Haagen Properties*
Ticker symbol: ACH
Exchange: AMEX
Friday close: $15.00
52-week range / Low: $13.75
52-week range / High: $18.25
52-week range / Yield: 9.60%
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Southern California REITs: Alexandria Real Estate Equities
Ticker symbol: ARE
Exchange: NYSE
Friday close: 29.63
52-week range / Low: 21.44
52-week range / High: 34.56
52-week range / Yield: 5.40
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Southern California REITs: American Residential Investment Trust
Ticker symbol: INV
Exchange: NYSE
Friday close: 9.00
52-week range / Low: 9.00
52-week range / High: 16.75
52-week range / Yield: 4.89
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Southern California REITs: Angeles Mortgage Investment Trust
Ticker symbol: ANM
Exchange: AMEX
Friday close: 19.00
52-week range / Low: 14.88
52-week range / High: 19.88
52-week range / Yield: 6.87
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Southern California REITs: Apex Mortgage Capital
Ticker symbol: AXM
Exchange: NYSE
Friday close: 10.44
52-week range / Low: 10.44
52-week range / High: 15.00
52-week range / Yield: 9.58
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Southern California REITs: Arden Realty
Ticker symbol: ARI
Exchange: NYSE
Friday close: 25.19
52-week range / Low: 24.94
52-week range / High: 32.38
52-week range / Yield: 6.67
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Southern California REITs: Burnham Pacific Properties
Ticker symbol: BPP
Exchange: NYSE
Friday close: 13.69
52-week range / Low: 12.75
52-week range / High: 15.75
52-week range / Yield: 7.67
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Southern California REITs: Excel Realty Trust
Ticker symbol: XEL
Exchange: NYSE
Friday close: 28.38
52-week range / Low: 25.94
52-week range / High: 35.63
52-week range / Yield: 7.17
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Southern California REITs: G&L; Realty
Ticker symbol: GLR
Exchange: NYSE
Friday close: 17.25
52-week range / Low: 15.75
52-week range / High: 21.75
52-week range / Yield: 9.04
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Southern California REITs: Health Care Property Investors
Ticker symbol: HCP
Exchange: NYSE
Friday close: 35.94
52-week range / Low: 32.75
52-week range / High: 40.38
52-week range / Yield: 7.07
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Southern California REITs: IMPAC Commercial Holdings
Ticker symbol: ICH
Exchange: AMEX
Friday close: 14.63
52-week range / Low: 14.00
52-week range / High: 20.75
52-week range / Yield: 9.44
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Southern California REITs: IMPAC Mortgage Holdings
Ticker symbol: IMH
Exchange: AMEX
Friday close: 15.56
52-week range / Low: 14.00
52-week range / High: 19.13
52-week range / Yield: 12.37
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Southern California REITs: Imperial Credit Commercial Mortgage Investment
Ticker symbol: ICMI
Exchange: NASDAQ
Friday close: 13.00
52-week range / Low: 12.88
52-week range / High: 19.13
52-week range / Yield: 5.00
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Southern California REITs: INMC Mortgage Holdings
Ticker symbol: NDE
Exchange: NYSE
Friday close: 22.06
52-week range / Low: 21.00
52-week range / High: 27.19
52-week range / Yield: 8.48
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Southern California REITs: Irvine Apartment Communities
Ticker symbol: IAC
Exchange: NYSE
Friday close: 28.31
52-week range / Low: 28.06
52-week range / High: 33.50
52-week range / Yield: 5.30
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Southern California REITs: Kilroy Realty Corp.
Ticker symbol: KRC
Exchange: NYSE
Friday close: 24.69
52-week range / Low: 22.00
52-week range / High: 30.00
52-week range / Yield: 6.56
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Southern California REITs: LTC Properties
Ticker symbol: LTC
Exchange: NYSE
Friday close: 18.56
52-week range / Low: 17.81
52-week range / High: 21.94
52-week range / Yield: 8.40
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Southern California REITs: Macerich
Ticker symbol: MAC
Exchange: NYSE
Friday close: 27.44
52-week range / Low: 24.75
52-week range / High: 30.38
52-week range / Yield: 6.71
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Southern California REITs: National Golf Properties
Ticker symbol: TEE
Exchange: NYSE
Friday close: 28.75
52-week range / Low: 28.13
52-week range / High: 34.75
52-week range / Yield: 5.98
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Southern California REITs: Nationwide Health Properties
Ticker symbol: NHP
Exchange: NYSE
Friday close: 23.50
52-week range / Low: 21.81
52-week range / High: 26.94
52-week range / Yield: 7.15
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Southern California REITs: Pacific Gulf Properties
Ticker symbol: PAG
Exchange: NYSE
Friday close: 21.44
52-week range / Low: 20.75
52-week range / High: 24.63
52-week range / Yield: 8.00
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Southern California REITs: Pan Pacific Retail Prop.
Ticker symbol: PNP
Exchange: NYSE
Friday close: 20.38
52-week range / Low: 19.75
52-week range / High: 22.75
52-week range / Yield: 7.46
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Southern California REITs: Price Enterprises
Ticker symbol: PREN
Exchange: NASDAQ
Friday close: 18.63
52-week range / Low: 17.13
52-week range / High: 20.25
52-week range / Yield: 7.52
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Southern California REITs: PS Business Parks
Ticker symbol: PSB
Exchange: AMEX
Friday close: 23.5
52-week range / Low: 19.31
52-week range / High: 25.75
52-week range / Yield: 4.26
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Southern California REITs: Public Storage
Ticker symbol: PSA
Exchange: NYSE
Friday close: 27.13
52-week range / Low: 26.13
52-week range / High: 33.63
52-week range / Yield: 3.24
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Southern California REITs: Realty Income
Ticker symbol: O
Exchange: NYSE
Friday close: 26.56
52-week range / Low: 23.75
52-week range / High: 27.81
52-week range / Yield: 7.51
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Southern California REITs: Sunstone Hotel Investors
Ticker symbol: SSI
Exchange: NYSE
Friday close: 12.75
52-week range / Low: 12.50
52-week range / High: 18.19
52-week range / Yield: 8.63
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Southern California REITs: Westfield America
Ticker symbol: WEA
Exchange: NYSE
Friday close: 17.69
52-week range / Low: 14.25
52-week range / High: 18.75
52-week range / Yield: 8.03
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NOTE: The Price REIT merged into Kimco Realty effective June 19.
Performance Comparison
Closing share prices of Manhattan Beach-based shopping center developer Alexander Haagen Properties Inc. are compared with performance of the Wilshire Real Estate Securities Index between June 1997 and May 1998.
Note: The Wilshire Real Estate Securities Index is a market-capitalization-weighted index of publicly traded real estate securities, such as real estate investment trusts (REITs), real estate operating companies (REOCs) and partnerships. The index is made up of companies whose charter is the equity ownership and operation of commercial real estate. The REIT share price return component is displayed in this overview.
Wilshire REIT Index: 236.19
Alexander Haagen Properties*: $14.81
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*Will become Center Trust Retail Properties
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Source: Deloitte & Touche
