REITs Seeing Renewed Investor Interest as Their Stocks Climb

Real estate investment trust stocks are getting some respect again.

Amid a generally lower stock market this year--and a crash in technology issues--the average REIT stock has risen 7.3% year-to-date, as measured by a Bloomberg index of 145 REIT shares.

With their high cash dividend yields, REITs are finding new favor with investors who are looking for safer havens in a volatile stock market, analysts and REIT executives say.

“We’re seeing a lot more activity in the REIT sector, both from retail and institutional investors, because people are realizing that there are such things as risk and reward,” said analyst Craig Silvers of Sutro & Co. in Los Angeles.

For REITs--which typically own and manage portfolios of properties, passing rental income through to shareholders via dividends--the renewed investor demand follows nearly two years of declining share prices caused in part by rising interest rates and in part by Wall Street’s fascination with other stock sectors.

The improving lot of REITs was a topic at the annual shareholders’ meeting of El Segundo-based Kilroy Realty recently. From a price of $19.75 on March 14, Kilroy stock has jumped 16%, to $22.94 now. In the same period the tech-dominated Nasdaq composite index has plummeted 32%.

Silvers projects that many REITs will generate “total” returns--share price appreciation plus dividend yield--of 25% to 30% this year. He names Kilroy, Los Angeles-based Arden Realty and Glendale-based PS Business Parks among his favorite REIT picks.

He also likes Palo Alto-based Essex Property Trust apartment REIT and Spieker Properties Inc., a Menlo Park-based office REIT, both with substantial holdings in Southern California.

Over the last five years, Essex has averaged 25% annual returns in combined dividend and stock price growth, and it’s up more than 20% so far this year, said Michael Schall, the company’s chief financial officer.

Keith Guericke, president and CEO of Essex, noted the company completed construction on a new 188-unit apartment complex called Mirabella in Marina del Rey late last year and already has leased all 188 units. Essex also has a number of apartment renovation projects underway in Southern California, Guericke said.

Recent financial results at Spieker typify the kind of growth that office REITs have been reporting.

Spieker’s funds from operations, a financial performance measure specific to REITs, rose to $72.4 million or 95 cents a share for the first quarter ended March 31, compared with FFO of $60.2 million or 81 cents a share for the first quarter of 1999, according to the company.

Spieker’s growth resulted in part from rent hikes typical of the increases that many landlords are commanding because of rising demand for office and industrial space, according to John Davenport, Irvine-based president of Spieker’s Southern California operations.

Spieker negotiated rent increases averaging more than 60% on more than 300 leases signed during the first quarter, Davenport said.

The current wave of increased investor interest in REITs is part of “a shift from technology and Internet stocks to safety stocks,” he said.

Senior analyst Jim Sullivan of Newport Beach-based REIT specialist Green Street Advisors Inc. said REIT stocks are looking better this year, but he estimates REIT returns will be considerably lower than Silver’s projections.

“REITS should return anywhere from 10% to 12% [price appreciation and dividend], which to us is a reasonable expectation for a long-term holder,” Sullivan said.

Sullivan said the 25% to 30% returns projected by Silvers “could happen,” but he advised that investors shouldn’t expect such performance on an ongoing basis.

“Year in and year out, REITs can’t produce those kinds of returns, except in especially opportunistic times like the early 1990s,” Sullivan said.

What the early 1990s provided was a depressed real estate industry in which REITs could buy properties at a discount. As Southern California pulled out of the recession, the values of those properties rose dramatically. For a time, REIT shares were viewed as popular growth stocks.

Despite steady earnings growth and an underlying real estate industry considered fundamentally sound, REITs have appeared stodgy compared with rocketing tech stocks, and REIT shares have been out of favor for several years.

“The reality was that people didn’t want slow growth,” said Victor Coleman, president of Arden Realty.

As the stocks declined in 1998 and 1999, many REITs could no longer raise capital cheaply through stock offerings. But they’ve found other capital sources, according to real estate attorney Matt Wyman of Cox, Castle & Nicholson.

Joint ventures have become a popular way for REITs to raise equity dollars through sources other than public capital markets. Wyman said REITs are forming two basic types of joint ventures.

In one type, the REIT owns or wants to buy a specific property to develop and has its own in-house development expertise, but it needs capital to finance the project, so the REIT takes on an institutional investor as a financial partner.

In the other type of venture, the REIT has property for development but doesn’t have in-house development expertise, so it takes on an outside developer as a partner.

“It seems to me the REITs that are going to do best right now are those that have development expertise, or can locate development deals, or understand a specific tenant base and can provide product to those tenants,” Wyman said.

Spieker has approximately $500 million of developments under construction, according to Davenport. Kilroy has more than $600 million worth of developments underway, President John Kilroy Jr. noted.

Kilroy has not turned to the type of joint ventures described by Wyman but instead has financed its developments through its $400-million line of credit, from its cash flow and by selling nonstrategic assets and reinvesting the proceeds in new projects, Kilroy said.

Another potential area of growth for REITs is to sell a variety of services, such as Internet access, to tenants. New federal legislation allows REITs leeway to provide services through subsidiaries.

“The subsidiaries will be nice to have because they might make decent profit contributions, but they won’t be a reason to invest in REITs,” analyst Silvers said.

Green Street analyst Sullivan said he’s skeptical about the wisdom of REITs competing against specialists in other industries, especially in providing wiring and telecommunications services to tenants.

“Should REITs be providing tenants with access to wiring? Of course they should, but they should be taking revenue-sharing agreements and leaving it at that,” Sullivan said. “They shouldn’t be trying to compete against venture capitalists by investing in the tech arena.”

Analysts and industry insiders see steady or even spectacular growth ahead for the industry, with or without growth in tenant services revenue.

Rising interest rates are a concern, but whether higher rates will slow REIT growth depends on whether the underlying economy and the resulting demand for real estate remain strong, analysts say.

Arden President Coleman said many, if not most, REITs “have been preparing for this [rising interest rates] for several years.” Silvers agreed, saying most REITs “should be OK as far as their profits go” despite higher rates.

If the economy remains strong, higher rates won’t necessarily bode ill for REITs because a growing economy “means there’s still a lot of demand for space,” Silvers said.

Rising interest rates generally dampen new construction, which could make already tight office and industrial markets even tighter, Silvers said. Higher rates could conceivably help apartment REITs by discouraging home buying, he said.

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A Sampling of Southland REIT Stocks

Here is stock information on some major real estate investment trusts based in Southern California. The dividend yield shown assumes the most recently paid quarterly dividend is paid in future quarters as well. But past dividends may not be indicative of the dividends a REIT will pay in the future. Investors should thoroughly research individual REITs before considering a stock purchase.

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Ticker Friday 52-week range REIT symbol Exchange close Low Alexandria Real Estate ARE NYSE $33.56 $27.75 Arden Realty ARI NYSE 22.75 17.63 Burnham Pacific BPP NYSE 6.44 6.00 G&L; Realty GLR NYSE 8.31 7.38 Kilroy Realty KRC NYSE 22.94 18.00 Macerich MAC NYSE 21.81 17.31 Nationwide Health Props. NHP NYSE 13.94 9.56 Pacific Gulf Props. PAG NYSE 22.00 19.25 Pan Pacific Retail Props. PNP NYSE 19.63 15.13 Public Storage PSA NYSE 22.38 20.81 Realty Income O NYSE 24.06 19.25 Westfield America WEA NYSE 14.44 12.00

Div. REIT High yield Alexandria Real Estate $34.81 5.1% Arden Realty 25.88 8.2 Burnham Pacific 12.94 16.3 G&L; Realty 12.38 6.0 Kilroy Realty 25.75 7.8 Macerich 27.25 9.4 Nationwide Health Props. 21.00 13.2 Pacific Gulf Props. 23.44 8.0 Pan Pacific Retail Props. 20.63 8.6 Public Storage 29.38 3.9 Realty Income 24.69 9.0 Westfield America 16.75 10.2

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Rebound for REIT Stocks

Real estate investment trust stocks have outperformed both Nasdaq and the S&P; 500 this year as many investors trade volatility for stability.

YTD Price Changes

REIT index: +7.3%

S&P; 500: --6.2%

Nasdaq comp.: --21.2%

Bloomberg index of 145 REIT stocks, monthly closes and latest.

Friday:

109.27