REITS..time to buy?

September 16, 2007
Square Feet | Ventures
REITs, Down Sharply, May Be a Good Buy
By VIVIAN MARINO
SOME investors might pronounce the heady days for real estate
investment trusts to be over, judging by their market performance this
year.

After seven consecutive years of extraordinary gains, REITs are
posting negative returns. Equity REITs, which own commercial property
and constitute the bulk of the market, had slid 7.73 percent, on
average, from the start of the year through Thursday (though they have
been improving of late), according to the National Association of Real
Estate Investment Trusts. Losses for mortgage REITs, which originate
loans and invest in mortgage-backed securities, were a staggering
43.62 percent on average in that period, the association said.

This year's slump has been attributed in part to profit taking (in
2006 alone, REITs returned 34.4 percent, on average, versus 15.8
percent for the Standard & Poor's 500 stock index), as well as the
frenzy over subprime mortgage defaults.

But some analysts think that the decline has been too severe and that
many REITs are poised for a comeback. Even as the market was swooning,
Standard & Poor's issued a report this summer offering a positive
outlook for many property groups, including the industrial, office,
retail and specialized REITs like lodging, self-storage and timber.

Keven Lindemann, the director of the real estate group at the research
company SNL Financial, said he agreed that "the fundamentals appear to
be fairly strong on most of the property sectors." And, depending on
an investor's time horizon, he added, "maybe that means it's a buying
opportunity."

So how do investors decide which REITs are worth acquiring now? Here
are six crucial areas to consider.

MANAGEMENT Ralph L. Block, the author of "Investing in REITs"
(Bloomberg Press, 2006) and publisher of The Essential REIT
newsletter, thinks strong management is paramount.

"With most REITs you're not simply buying commercial real estate — you
have no ability to decide which assets to buy or sell; you can't
control the development activity or the balance sheets — what you're
really doing is relying on a management team to make good, sound
long-term decisions with regard to a real estate company," Mr. Block
said.

To help evaluate a team, he said, compare the company's performance
with its peer group over the last five years. Profitability and asset
appreciation are closely associated with managers' ability to choose
the right investments and best strategies.

Leadership is important, too. "Are these the go-to people in their
sector, and are they the most likely to get the first call and the
only call in various transactions?" said John J. Kriz, the managing
director of real estate finance for Moody's Investors Service.

ASSET QUALITY Because real estate markets fluctuate by location and
property type, diversification can be a crucial ingredient to a REIT's
overall success.

"What you like is a company with leadership in multiple areas," Mr.
Kriz said. "Having all your eggs in one basket can be risky. If the
Florida economy starts coming undone, that may weaken the value of
those assets there, but if you have assets elsewhere, you can
compensate for that."

(Brad Case, the vice president for research and industry information
at the National Association of Real Estate Investment Trusts, calls
that "granularity — it means that if one of my investments blows up,
my others won't have the same problem.")

Mr. Block recommends owning REITs with higher-quality assets in
healthy urban areas right now, rather than in suburban markets,
"because those assets are going to be more in demand by a more stable
renter group. People are always going to want to be in Manhattan."

Mr. Lindemann agreed that sticking with the tried-and-true was helpful
in uncertain times. "You probably don't go wrong," he said, "by
looking at some of the largest companies that have dominant positions
within their sectors and have experienced management teams that have
been through the up cycle and down cycle and they don't get overly
exuberant when things go great or overconcerned when going down."

GROWTH PROSPECTS The best-run REITs are continually expanding —
acquiring new properties as they shed some of their existing ones, or
planning future developments. "You'll want to know about their
development pipeline," Mr. Block said.

Some companies will also branch out into other areas, like, say,
providing financing or management services for property outside the
REIT; a balanced mix is best. Additional income can be derived as well
by raising rents and fees, along with reducing debt.

Mr. Kriz, though, asserted that it is important for REIT companies to
have ample access to the capital markets to expand. "Because REITs
need to 'dividend' essentially all taxable earnings every year,
they're fundamentally incapable of retaining much of any cash," he
said, "and so a REIT cannot generate liquidity on its own by retaining
income."

BALANCE SHEET The funds from operations, or F.F.O., is a good way to
measure cash flow and profitability.

Unlike the figures used by most corporations, F.F.O., sometimes quoted
on a per-share basis, is calculated by adding in depreciation and
amortization expenses to earnings. The price-to-F.F.O. ratio, a common
valuation tool to determine whether a REIT is cheap or expensive, is
derived by dividing the price of a REIT's stock by the sum of its
funds from operations for the previous four quarters.

"Look carefully at the volatility of the returns — stable earnings
means earnings that I can count on to pay my dividends and to service
debt," Mr. Kriz said. Also, he said, "the more leveraged the company
is, the smaller its margin of safety to address reverses in operating
performance."

What's reasonable? "Between 45 and 55 percent total leverage," Mr.
Block said, "though there are some property sectors like malls where
leverage can get up to 62 percent."

VALUE As with any investment, the idea, of course, is to buy low and
sell high, though knowing when to jump in can be difficult for average
REIT investors. Looking at the net asset value, or N.A.V. — the value
of a REIT's properties minus its debt, or the equity it owns in its
properties — can help.

"The value of the REIT should be equal to the value of the underlying
assets with some discount or premium given to the quality of the
management," said Mr. Case of the REIT association. Right now, he
said, citing industrywide data, REITs are trading at a significant
discount to asset value. But "the bigger the discount to N.A.V.," he
said, "the better you can expect the returns to be."

YIELD Dividends are the reason most people buy REITs in the first
place. The companies, after all, are required to disburse most of
their profits as dividends to shareholders in exchange for
preferential tax treatment. Last year, REITs paid out about $15.5
billion in dividends, according to the REIT association.

But simply chasing dividend yields is not advisable. Make sure the
dividend yield is in line with its peer group, experts say. The
average dividend yield — the share price divided by the annual
dividends — now is 4.28 percent, though REITs in out-of-favor sectors
typically have higher dividends, like home financing and commercial
financing, which are 11.95 percent and 14.83 percent, according to the
association.

WHERE TO FIND INFORMATION... The best place to go is online. Most of
the 190 or so publicly traded REITs maintain Web sites. But the most
detailed information can be found at the sites of the National
Association of Real Estate Investment Trusts (nareit.com or
investinreits.com), which offer material like regular price quotes,
historical performances by sector and links to individual company
sites.

Other REIT sites include reitcafe.com, which provides access to
interviews with REIT executives, analysts and institutional investors,
along with podcast programs and links for blogs, and
reituniversity.com.

Financial and brokerage firms, meanwhile, will have analysts who
follow the real estate industry and can provide data. Also, many
public libraries carry Value Line Investment Survey, which publishes
weekly reports on publicly traded companies. In addition, Standard &
Poor's sells research reports.