Sweet REITs Face
Challenges in 2002

REITs continued to be a haven for investors in 2001, outperforming Standard & Poor's 500-stock index and posting better earnings growth than most industries -- though slower than in past years.

So can real-estate investment trusts keep up that pace in 2002?

"If we return to a bull market, the S&P 500 will do very well, but it would be unrealistic to expect REITs to keep up," says Mike Kirby, principal at Green Street Advisors Inc., a real-estate research firm in Newport Beach, Calif. But, he adds, "REITs will still do OK." And many analysts would agree.

REITs had an average total return of 13%, including dividends, for the year as of Dec. 27, according to the Morgan Stanley REIT index, while the S&P 500's total-return index fell by 11%.

REITs that paid out higher dividends to shareholders outperformed growth-oriented REITs paying out lower dividends. Credit Suisse First Boston analyst Lawrence D. Raiman expects that trend to continue, at least through the beginning of 2002, as the weak economy slows REITs' earnings growth and investors seek companies that provide more income.

Mortgage REITs were the top performers, with an average return of 82% for the year as of Dec. 27, according to the National Association of Real Estate Investment Trusts. The group benefited from the Federal Reserve's aggressive cutting of interest rates, which made the REITs' borrowing costs less expensive and, thus, increased their earnings.

But analyst Gary Gordon of UBS Warburg in New York says the streak could end if the economy rebounds in the second half of 2002 and the Fed starts raising rates.

Office REITs saw their returns rise on assumptions that the office market isn't at risk of oversupply. Mortimer B. Zuckerman, chairman of Boston Properties Inc., a Boston-based office REIT, says the office sector is poised to weather this downturn better than past ones because this time "there is little in the way of vacant new supply coming onstream."

Overall, two major events boosted the sector: the addition of the industry's two biggest REITs, Equity Office Properties Trust and Equity Residential Properties Trust, to the S&P 500; and analysts' decision to forecast REITs' financial performance using a net-income figure in addition to the industry's supplemental measure, funds from operations. "The inclusion provided the REIT sector with much-needed credibility as an equity-stock alternative," says Patrice Derrington, managing director at Victory Capital Management, a New York investment adviser. "The new performance guideline will facilitate the comparison of REITs with other equities."

Analysts expect S&P to add the industry's third-largest company, Simon Property Group, an Indianapolis-based mall owner, to its 500-stock index in 2002.

Yet everything didn't come up roses for REITs in 2001. Fallout from the Sept. 11 attacks put pressure on the sector, mainly hotel REITs. Those had a total return of minus 10% after Sept. 11. The attacks led to huge cutbacks in travel and leisure spending, prompting FelCor Lodging Trust Inc., of Irving, Texas, and MeriStar Hospitality Corp., Washington D.C., to cancel merger plans.

Many lodging REITs suspended their dividend payments to shareholders in the fourth quarter. And hotel REITs' dividend outlook for 2002 "remains very uncertain," says Mike Rietbrock, lodging analyst at Salomon Smith Barney in New York.

REITs flirting with technology often got burned. Despite some expensive failures, analysts say there will still be a role for technology in real estate. "REITs will use technology as a way to operate their businesses more efficiently," says Lee Schalop, analyst at Banc of America Securities in New York, "not as a way to grow their business."

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