Choosing the REIT stuff: here's how to find opportunity in a down market

Black Enterprise, Feb, 1995 by Steve Bergsman

Owning land is still one of the highest priorities on the African-American wish list. However, a combination of higher mortgages and lower property values has dimmed some traditional opportunities and turned the spotlight on a less expensive investment choice, the real estate investment trust, or REIT.

A REIT is a publicly traded company fund with its assets in some form of real estate. The REIT can invest solely in commercial property, as does Mark Centers Trust (NYSE symbol: MCT), which owns and operates shopping centers, or it can invest in residential property like the holdings in Avalon Properties (NYSE symbol: AVN) portfolio. REITs can also hold assets that comprise a mixture of the two. To find out the assets of a REIT before you buy, read the fund's prospectus.

When considering a REIT investment, a key item you should look at is growth potential. Investors in REITs ought to be looking at companies that will deliver the best total returns, which are a combination of dividend and capital appreciation. If an investor finds a company that pays a 7% dividend, then he should also look for an 8% growth rate in what are called "funds from operations," the REIT equivalent of earnings. This figure is sometimes listed next to the acronym FFO in the analyst's report or in the prospectus.

Add the dividend to the increase in FFO or growth rate over the next 12 months to get the expected rate of return.

From a tax standpoint, REITs, like other real estate investments, have an inherent advantage. A portion of most REIT dividends is treated as a return of capital. So if a REIT is paying out $1 a year and 40% is return of capital, the investor is subject to tax on only 60 cents.

The two most obvious advantages for investing in a REIT are liquidity, the ease with which you can get in and out of the investment, and the natural spread of assets, which means less risk.

"It's a good way for small investors to get into real estate, just because it is more liquid than buying an office building," says Bedford Lydon, a REIT analyst with Salomon Brothers in New York.

Not long ago, there weren't many Pelts listed on any of the stock exchanges. But coming out of the recession, the REIT market began to pick up steam. Last year, a record $9.3 billion was raised as 50 new REITs began trading. Through the first 10 months of 1994, 40 new REITs raised $6.5 billion. That activity has been both a blessing and a curse for investors. The popularity of REITs has allowed individual investors to pick and choose among the best real estate portfolios in America. On the other hand, some weaker companies have ridden the successful wave created by the stronger companies.

One of the most notorious disappointments for investors was American Industrial Properties (NYSE symbol: IND), which went public in 1985 at $15 and has since declined to $1.25. Clearly, using REITs as a long-term growth and income strategy requires a lot of homework and the advice of a qualified investment advisor.

Lately, the biggest block of REITs, 22% of the total now trading, is in apartment complexes. This sector is being helped along by higher interest rates and the fact that first-time home buyers are waiting to see where the economy will go.

At the end of the third quarter last year, office/industrial REITs, as rated by total returns, were the best performing of the various sectors, followed by hotels, regional malls and self-storage diversified portfolios. Factory outlet centers were the poorest performers.

But, Barry Vinocur, who follows the industry in the Realty Stock Review newsletter, thinks that outlet centers may be undervalued. "The stocks are down," Vinocur says, "as there has been a large sell-off by institutions, but we see the sell-off as an opportunity to buy the best-quality companies at bargain prices. The numbers coming out of these companies show exciting growth ahead."

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