Rei Ts Won't Be Wrecked By Reforms

The news about REIT reform may not be as sexy as some other Washington headlines these days. But real estate investment trusts have grabbed the attention of investors. After President Bill Clinton lobbed a few grenades at the REIT industry in his 1998 budget proposal, Wall Street slammed several REITs hard.

What's the Administration up to? In an acquisition frenzy, several REITs have cleverly dodged prohibitions against collecting non-real-estate earnings. In the last year, REITs have snapped up mammoth corporations such as ITT and ventured as far afield as car dealerships and movie theaters. Clinton aims to clamp down on this stampede by taxing any acquisition of a corporation by a REIT. The Administration is also going after a few REITs with a grandfathered structure called "paired shares" that lets REITs own and manage operating businesses such as hotels. Clinton would prohibit future deals using the structure.

That doesn't mean you should avoid REITs, however. Clinton's plan would affect a handful of existing REITs. For the biggest of those, the blow will be a scrape. Many observers think Congress will ignore most of Clinton's wishes. "I'd be shocked if his proposals go through as is," says Lehman Brothers tax maven Robert Willens.

Whether or not you're willing to bet on Clinton's getting his way, some REIT-watchers think the best buys right now are the two that did the most to provoke the government: Starwood Hotels & Resorts and Patriot American Hospitality. As paired shares, each consists of a tax-exempt REIT and taxable corporation trading as one stock. This gives them the tax advantages of a REIT but the operating flexibility of a public corporation. They have exploited this edge. After buying Westin Hotels & Resorts last fall, Starwood pushed aside Hilton to take over ITT and its Sheraton hotels for $14.6 billion. Patriot has bought Wyndham and Interstate hotels. Each has cash flow that's expected to grow at a 30% annual rate over the next two years even without another deal. "Back up the truck, and load it up," says Jonathan Litt of PaineWebber. "It's time to buy."

The two other paired-share REITs, Meditrust and First Union, face leaner times. With their acquisition plans still unrealized, Clinton's proposal would pull the rug out from under them. A less direct target of the Clinton plan is a group called "paper-clip" REITs. Texas investor Richard Rainwater invented the structure last year when he spun out a small operating company from Crescent Real Estate Equities into a separately traded corporation called Crescent Operating. Rainwater has gotten around REIT restrictions and gone into managing psychiatric centers, spas, and refrigerated warehouses. He recently added Station Casinos in Las Vegas to his empire. With more paper clips in the offing, rumors of a REIT buying spree on the Vegas strip are flying.

LICENSE TO WANDER. If Congress approves Clinton's proposed tax on corporate acquisitions by REITs, Vegas may not fall as fast. However, investors should be wary of paper clips. Their structure gives the REIT license to wander into riskier areas. Since its casino play, Crescent's shares have fallen 10%. While this may be a buying opportunity for those comfortable with Rainwater's venture-fund-like approach, investors might be wise to steer clear of paper clips such as Excel Realty Trust and Reckson Associates Realty. "The idea of REIT conglomerates scares the hell out of me," says Steven Hash of Lehman Brothers.

It's not hard to stay away from pairs and paper clips. About 200 REITs make their money by acquiring, managing, and developing properties. They're not a target of Clinton's proposed reforms, and Russell Platt, head of real estate funds at Morgan Stanley, Dean Witter, Discover, expects them to outperform the Standard & Poor's 500-stock index this year. Cash flow for the industry is expected to grow by 11% in 1998. On top of that, you can expect an average yield of 5%. Issues that are worth buying include dominant office REITs such as Equity Office Properties, Boston Properties, and CarrAmerica. For many real-estate boosters, there's no treat as sweet as a REIT.

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