REITs Can Be a Roof over Your Head

They offer outsize dividends even in a recession

Can real estate investment trusts (REITs) pull off a hat trick? They delivered an impressive total return of 29% in 2000 and a solid 11.5% in 2001, a period when the stock market was in a dive and the economy was sliding into a recession. Sure, vacancy rates are up and rents down, but REIT investors believe they will make money again in 2002.

What's most attractive about REITs, which are real estate holding companies, is their outsized dividends. Required by law to distribute at least 90% of their taxable income to shareholders, REITs boast an average yield of 7.5%. That's five times the dividend yield on the Standard & Poor's 500-stock index and far ahead of high-quality bonds, certificates of deposit, and money-market funds, which weren't paying even a third as much at yearend.

With that 7.5% head start, all it takes is 2.5 percentage points in share-price appreciation for REITs to hit double-digit returns again. And analysts and fund managers believe shares should go up by at least that much, no matter what happens to the overall market. For one thing, REITs have shown that they can prosper even in a recession.

What if other stock sectors rebound on an economic recovery? Granted, that could lure some investors away, just as the tech stock boom put REITs in the doghouse a few years ago. But analysts point out that landlords should profit from a resurgent economy, too, since they would be able to attract more tenants at higher rents. And fortunately for REITs, there's not too many new buildings opening in 2002. Lenders have been loathe to finance buildings unless builders had lined up tenants first. The bottom line: REITs, on average, should produce a 12% total return in 2002, says Keith R. Pauley, managing director of LaSalle Investment Management.

Today's best bets, say the pros, are industry leaders such as Equity Office Properties Trust. They have top-notch management teams, strong balance sheets, and such geographically diverse portfolios that they can weather downturns handily, whether it's the burst dot-com bubble in San Francisco or the blow from terrorism in Manhattan. Although new-lease rents are down from 2000's peak across the U.S., Equity Office Properties, for instance, was still raising rents by an average of $4.50 per square foot in late 2001. How's that possible? Tenants whose leases are up for renewal typically have been paying rates set 10 years ago. Even today's lower rents are higher than they were back then.

Although some retailers are hurting, analysts still see value in shopping-center REITs. Analysts Steve Sakwa of Merrill Lynch & Co. and Jonathan Litt of Salomon Smith Barney like Simon Property Group. The largest owner of regional shopping malls, Simon has 90.6% of its space occupied, thanks to long-term leases. The two also recommend Vornado Realty Trust, which complements its collection of office towers with retail properties and wholesale sites such as Chicago's Merchandise Mart. And Sakwa likes Kimco Realty Corp., the king of supermarket-anchored shopping centers.

There are REITs to avoid. Because they rely almost entirely on annual leases, residential property REITs will lag the industry in early 2002, as hard times depress demand for apartments. The hotel sector is also getting walloped by the post-September 11 drop in travel. Indeed, Host Marriott Corp. suspended its common dividend Dec. 5. Analysts also urge investors to stay away from National Golf Properties Inc., which has warned that its largest tenant may not be able to pay its rent through the winter.

But for every National Golf, there is a Capital Automotive REIT. A favorite of analyst Lawrence D. Raiman of Credit Suisse First Boston, Capital Automotive owns 260 car lots, which it then leases to dealers under long-term contracts. The REIT has hiked its dividend 15 quarters in a row and now yields a bountiful 8.2%. That's a payout most any investor can appreciate.

By Michael Arndt

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