The rise of REITs boosts commercial real estate

THE BALTIMORE SUN

Abraham Rosenthal remembers a time not long ago when he could name virtually all of the nation's real estate investment trusts off the top of his head.

"Now, I can barely keep track of the ones in our business, much less all the others," said the chief executive officer of Prime Retail Inc., a Baltimore-based REIT that specializes in the ownership and development of outlet center malls. "It's mind boggling."

Indeed, over the past four years, more than 250 publicly-traded REITs have altered the nation's commercial real estate landscape: They have tapped into capital markets to retire excessive debt amassed in the 1980s, and fueled an ever-growing acquisitions machine. Last year, for instance, 141 offerings generated record proceeds of $18.3 billion and pushed the industry's market capitalization above $42 billion, according to statistics compiled by the National Association of Real Estate Investment Trusts (NAREIT), a Washington, D.C.-based trade group.

The proliferation of REITs and the shift toward public ownership of real estate has affected Baltimore and the rest of the state as well.

Over the past 14 months, four locally based privately held concerns have converted to equity REITs -- Town & Country Trust, Mid-Atlantic Realty Trust, Prime Retail and Storage USA Inc.

In addition, more than two dozen companies have acquired significant holdings or folded properties here into converting trusts.

REITs active in the Baltimore metropolitan area control no fewer than 40 major apartment complexes, six regional malls, 35 community retail centers and 25 office and industrial properties totaling more than 17 million square feet, according to a survey of company annual reports. At that figure, REITs collectively own more space than exists in all of downtown's 140 office buildings.

In all, 45 equity REITs own more than $1.4 billion worth of property in Maryland, with an emphasis on retail and apartments, according to NAREIT figures.

"Our market has been discovered as a stable area, and as a result, more and more REITs are looking at it," said Harvey Schulweis, president of Town & Country, which became the area's first equity REIT when it went public in August 1993 through a $341 million initial offering.

Moreover, many analysts contend that REITs will soon come to dominate ownership of local commercial and multifamily real estate.

"What REITs do is provide a platform for access to capital," said Robert A. Frank, an Alex. Brown managing director and one of the nation's foremost REIT authorities. "And the major factor of production in the real estate business is capital. Like most industries, the ones that have the lowest cost of capital are the most successful."

Furthermore, Mr. Frank said, "REITs create a platform for real estate to be run as a business, because it provides for better, more disciplined management."

Since January 1985, Alex. Brown has been the primary underwriter on 72 REIT offerings that raised $4.8 billion, second only to Merrill Lynch, the nation's largest investment house.

For developers, trusts represent a vehicle to generate working capital and retire debt at a time when traditional sources such as banks and insurers have disappeared from the lending arena. It was access to capital that prompted Prime Retail to go public last March.

"We're developing between $100 million and $150 million worth of new centers annually," Mr. Rosenthal said. "For that kind of sustained growth, we needed a predictable and sustained source of funds that we could only get through public capital markets."

Liberty Property Trust, the Philadelphia-based successor corporation to Rouse & Associates Inc. and owner of 19 office and industrial buildings in Maryland, used its initial public offering to pay off more than $461 million in outstanding mortgages.

REITs also provide a mechanism to avoid corporate income tax, contingent on the distribution of 95 percent of their taxable income to shareholders through dividends.

Conversely, REITs offer shareholders a relatively liquid form of real estate ownership through securities, generating average yields between 7 and 10 percent. Trusts also offer diversification, a key to institutional investors and pension funds which are increasingly devoting funds to REITs.

"For those who want to diversify their portfolios and want to buy real estate, there is nowhere else where one can get a liquid investment with expert management in place," said F. Patrick Hughes, chief executive of Mid-Atlantic Realty Trust, a Linthicum-based REIT which concentrates on community shopping centers.

By the year 2000, Mr. Frank expects REITs to evolve into a $200 billion industry, a figure equal to roughly 10 percent of all the commercial real estate in the United States.

That anticipated growth is likely to increase interest by REITs in Maryland. Although the majority of REIT-owned property here is in the hands of the locally based companies, out-of-state firms are increasingly considering Maryland when searching for property.

The latest examples include United Dominion Realty Trust, a Richmond, Va.-based trust that acquired four area apartment complexes in July as part of a $188 million package, and Kimco Realty Trust of New York, which is negotiating to purchase the Towson Marketplace for an estimated $13 million.

In addition to increased competition driving prices up, REIT interest in area projects is expected to eventually increase state property assessments and ultimately the amount of taxes generated.

In fact, many analysts point to REITs as the primary factor behind the nation's and the Baltimore market's commercial real estate recovery in many segments, which just a year ago appeared to be little more than a remote possibility.

And various REITs have invested significant amounts to revamp and improve older, deteriorating properties. Federal Realty Investment Trust, for instance, invested a total of $21.2 million to buy and improve the Perring Plaza Shopping Center, replacing vacant space with tenants such as Home Depot Inc.

Larger retail properties have been affected as well. Of the 20 major malls in the area, six are now controlled by REITs, including the Tow son Town Center, Harford Mall, Glen Burnie Mall, Golden Ring Mall and Marley Station. Together, they total 3.6 million square feet and represent more than $400 million worth of real estate.

But more than any other asset class, it is the apartment market that has been the most affected. REITs have sought out multifamily projects because they have traditionally experienced low vacancy rates, stable cash flows and a lack of overbuilding.

Since the start of last year, virtually every major apartment sale has involved a REIT eager to capitalize on the area's solid demographics and income levels. As a result, all buyers are now dealing with increased prices and overheated competition.

Avalon Properties Inc., which folded seven Maryland complexes developed by Trammell Crow Residential into its portfolio following its $390.5 million offering last November, intends to begin its planned Chase Grove complex in Gaithersburg by year-end, partly as a result of the lack of new buying opportunities.

But amidst the rush for properties among REITs and the industry's tremendous growth, many analysts point to forces that could result in a wave of changes in the not-too-distant future.

Wall Street has already begun to differentiate between REIT offerings, leaving many less than stellar trusts without proper financial backing and forcing some to postpone IPOs indefinitely. Many analysts such as Alex. Brown's Mr. Frank also believe industry consolidation is inevitable.

"As it should be in any industry, there will be an ordering of these companies, and the companies that lose focus will become targets for acquisitions," said Thomas E. Robinson, president and chief operating officer of Storage USA Inc., a Columbia trust owner and operator of self-storage facilities. "With the change to public ownership, real estate isn't being treated differently than any other business."

Both Town & Country and Mid-Atlantic Realty executives, for instance, indicated they would entertain a possible merger if it were in the best interest of shareholders.

Mr. Robinson adds that as pension funds and institutional investors such as the Equitable Cos. become more active REIT buyers, they will exert more influence and be less patient with trusts that fail to meet financial expectations.

The recent boost in interest rates hasn't helped the REIT industry's fortunes either. On average, REIT stock prices have dropped 15 percent this year, which has lessened various companies' ability to complete secondary stock offerings for future acquisitions, and made REIT stocks less attractive when compared to U.S. Treasury bonds or utility stocks.

Furthermore, the interest rate movement has begun to influence REITs' ability to make significant amounts of money on new investments. When interest rates were low, for instance, REITs were able to raise money at a 6 percent rate and buy properties yielding 9 percent. With the rate hike, overall returns have dipped, along with investors' interest.

Maryland REITs, including Town & Country and Mid-Atlantic, have suffered from the downward stock trend since converting to trusts as well, but it is too soon to tell whether the lowered stock prices represent an ephemeral trend or a market and investor re-evaluation of the companies' assets.

REITs and industry analysts, however, contend that as long as their underlying properties are sound, and cash flow projections hold and occupancy rates rise, the industry will weather the interest rate storm.

OTHER MARYLAND-BASED REITs:

FEDERAL REALTY INVESTMENT TRUST:

Headquarters: Bethesda

Initial public offering: $2.25 million, September 1962*

Chief executive officer: Steven J. Guttman

Portfolio: 51 retail centers totaling 11 million square feet.

Largest local holding: Perring Plaza Shopping Center.

SAUL CENTERS INC.

Headquarters: Chevy Chase

Initial public offering: $228 million, August 1993.

Chief executive officer: B. Francis Saul II

Portfolio: 26 retail centers and three office projects totaling 5.3 million square feet in eight states and the District of Columbia.

Largest local holding: Southdale Shopping Center, Glen Burnie. Note: * The company originally sold warrants for 500,000 shares of stock. The $2.25 million represents the amount raised from the sale of those warrants.

'Source: Company reports

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