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Research analysts are split on REIT outlook

By Phyllis Feinberg

With cap rates on acquisitions falling and the stock prices lagging badly behind the Dow Jones Industrial Average and the Standard & Poor's 500 index, some research analysts think stocks of real estate investment trusts (REITs) will continue to underperform the overall market.

However, other analysts, who think the best time to buy a stock is when it is most out of favor with the masses, believe now may be a good time for investors to increase their purchases of REIT stocks.

Lawrence D. Raiman, senior REIT analyst at Donaldson, Lufkin & Jenrette Securities Corp., New York, created quite a stir several months ago when he issued a report downgrading REITs to a "market performance" rating from an "outperform" rating.

He listed several reasons for his action. First, REITs are moving towards a peak in their business cycle as increasing amounts of capital become available to the real estate industry.

"While the commercial real estate rebound is not yet complete, $100 billion plus of annual capital inflows has created cap rate compression and lower return potential on new investments. New construction activity should also inhibit future rental rate and occupancy gains," the report said.

Therefore, "upcoming rates of returns achieved by REITs should be lower than those achieved in the last several years," he stated.

Mr. Raiman also pointed out that, "REIT trading multiples are more efficient; property segment biases [among office, retail and residential] as well as geographic biases are now better reflected in current trading prices."

He recently reiterated this position, and is still bearish on REIT stocks. "I still feel the same way about the stocks," he told SCT.

However, others think that REIT multiples will increase, and that lower stock prices present a good buying opportunity.

Jonathan Litt, senior REIT analyst at Paine Webber, New York, recently issued a report upgrading the REIT industry, recommending that investors overweight the group in their portfolios.

"We believe the group has been weak because of noise [talk and concern about issues -- such as the Clinton budget proposal -- that have nothing to do with the real estate fundamentals] in the marketplace, most of which will not have a material impact on REIT earnings growth rates. We believe the time to buy is when investor sentiment is the most negative," he stated.

"We believe REITs are both a good offense and a good defense."

On the offense: Mr. Litt said that REITs will provide a growth rate two to three times greater than that expected for the S&P 500 in 1998 and 1999. Paine Webber expects the S&P 500 to have annual growth of 5.8% in 1998 and 6.6% in 1999.

On the defense: Mr. Litt points out that REITs "have a low correlation to the broader stock (0.30), and bond markets (0.27). REIT multiples trade at a 53% discount to the S&P 500 multiple, the lowest level in the past four years."

Gary Boston, who follows retail REITs for Paine Webber, expanded on Mr. Litt's thesis. "The earnings for REITs are growing at about 20% a year. At some point the fundamentals have to win out," he told SCT.

"People say REITs are overpaying for acquisitions," he added, "But the reason real estate prices are going up is because fundamentals for the industry look good."

Mr. Litt's report recommends that investors overweight the group for the first time since 1994. Paine Webber has also increased the percentage of buy rated stocks in its universe to 20% from 10% and has also decreased the percentage of stocks on which it is neutral to 18% from 23%.

In a related report, Mr. Litt said that The Macerich Co., Santa Monica, Calif., "remains our top pick in the retail sector." He added, "Macerich was the fastest-growing regional mall company in 1997 and we see an opportunity for another two years of sector-leading growth."

Two other retail REITs, General Growth Properties and Bradley Real Estate, both based in Chicago, were among the stocks Paine Webber upgraded to a "buy" rating.

Concerning GGP, the report points out that its stock is trading at a 2% discount to the average price of regional mall stocks.

"With better-than-average growth forecast and potential upside to our [earnings] estimates, we believe the shares should trade at a premium to the group. We are maintaining our $41 price target, which represents a 24% total return from here," the report states. The stock closed at 35 15/16 on June 26.

About Bradley, Mr. Litt points out that the REIT "has established itself as the consolidator of this property type [grocery-anchored shopping centers] in the Midwest region." Bradley recently acquired Mid-America Realty Investments, Omaha, Neb., for $153 million. The purchase includes Mid-America's interest in 25 strip centers.

Mr. Litt also stated that Bradley's market capitalization may approach $1 billion (it is now at $772 million) over the next year, "which will put it in the top five in the sector and put it on many more institutional [investor] radar screens."

Mr. Litt expects a total return of close to 24% for Bradley as well, with a stock price target of $24 per share. The stock closed at 21 on June 26.

DLJ's Mr. Raiman does have a buy rating on several REIT stocks, including two retail REITs: Simon DeBartolo Group, Indianapolis, and Pan Pacific Retail Properties, Irvine, Calif.

Simon "has had earnings growth in the midteens level and has improved the quality of its portfolio over the last few years," Michael Mueller, retail REIT analyst at DLJ, told SCT.

Pan Pacific is poised for continued growth in the strip shopping center business in the Western United States, according to a recent DLJ report. "PNP's portfolio continues to be located in the right markets at the right time," the report said.

Mr. Litt has also upgraded the rating on Taubman Centers, Bloomfield Hills, Mich., to "attractive."

The rating was raised because "we believe the current share price does not reflect the current cap-rate environment for assets of Taubman's caliber," he said. He also said that Taubman "owns one of the highest-quality and most productive portfolios of regional malls in the country." including The Mall at Short Hills, N.J.; Beverly Center in Los Angeles; and Woodfield Mall, Schaumburg, Ill.

Taubman stock should have a total return of about 18% over the next year, according to Mr. Litt. The stock closed at XXXX on XXXXX.

Burland B. East, managing director and head of real estate research at Everen Securities, Chicago, has also issued a positive report on REIT stocks titled: "Don't worry, fundamentals are excellent."

Merger activity among REITs should continue to increase, according to the report.

"It is two weeks before prom night and dates are getting scarce," Mr. East says. "We believe we have entered what will be a heated courtship for the 146 companies in our index. Many of the previous mergers were a function of, 'Help, I've fallen and I can't get up,' i.e., crippled companies lacking any better options that would make alliances with other companies to put themselves out of their misery."

"What appears to be happening now, however, is healthy companies with independent options seeking larger and more advantageous platforms from which to expand their businesses," the report contends.

Mr. East does not specifically name which REITs he believes are good takeover targets because, he told SCT, "speculation creates enormous amounts of unrest at the firms and uncertainty among employees. It's like being at a cocktail party and asking which couples you think will get divorced."

One retail REIT stock he's recommending now is Burnham Pacific, San Diego. "Burnham's strategy of investing in grocery-anchored, high-density locales is among the most stable and astute in the retail sector," Mr. East said.

Burnham has also entered into a $500 million joint venture with the California Public Employees Retirement System (CalPERS) to purchase and manage all of the nonmall retail assets of the nation's largest public pension fund.

Mr. East also likes Chelsea GCA Realty, Roseland, N.J., which, he says, "owns the highest-quality and best-located outlet centers in the country," including Woodbury Common Premium Outlets, Central Valley, N.Y.

With opinions among analysts divided, the truth remains that investors have to make their own, individual investment decisions, based on analysts' advice. And companies looking for new investors must make their case to analysts.