Analysts Not Concerned
Despite Trusts' Plunge

Real-estate investment trusts continued to get hammered last week on concerns about rising interest rates and bubbly valuations.

The recent sharp declines, after four years of huge gains, is prompting worries that REITs will descend into a two-year bear market similar to the one suffered in 1998 and 1999, when their total returns were down 19% and 6%, respectively.

But a number of REIT money managers and analysts say they believe the current downturn represents nothing more than bringing prices back in line and that investors shouldn't panic. And some are recommending certain REIT sectors that may benefit from a recovery in the U.S. economy.

The hardest-hit sectors have been the ones with the best prospects, namely REITs that own malls and shopping centers and those that own health-care facilities such as nursing homes. Money managers and analysts say that investors should focus on those relatively healthy sectors now, especially because the severe beating they've taken has made for some bargains.

REIT stocks began their decline immediately following the release April 2 of stronger-than-expected March jobs numbers. The report sparked a rise in bond yields and fears the Federal Reserve will raise interest rates.

REITs by law must pay out 90% of their taxable income in the form of dividends, and those dividends are a big reason for REITs' popularity. Their average dividend yield as of last Thursday was 5%, compared with 1.67% for companies in the S&P 500 and 3.9% and 4.82%, respectively, for the 10-year and 30-year Treasury, according to Morgan Stanley. The fear is that higher interest rates will make other investments more attractive from a yield standpoint.

Analysts also say the employment report has the potential to make other investment sectors, where companies are doing the hiring, look more attractive than REITs.

Another factor contributing to the weakness is a growing belief that REITs are pricey. Indeed, before the slide, REITs traded at a price-to-earnings ratio of about 18.5, compared with a historical ratio of 12, according to Green Street Advisors Inc., a Newport Beach, Calif., real-estate research firm.

The fast and furious decline of REITs hasn't shaken Andy Duffy, portfolio manager of the real-estate-securities fund at TIAA-CREF, the big retirement system for higher-education and research employees. "We believe this is a correction, not the beginning of a bear market," said Mr. Duffy. "My view is that it's a long-overdue correction. By almost any measure, REITs had gotten expensive. The fundamentals have actually been pretty awful." REITs were ripe for a pullback, he said, adding, "We are more committed to owning them at these prices than a few weeks ago when they were more expensive."

While REITs as a whole have dropped, some sectors have fallen harder than others. Mall REITs, for instance, have declined 17.9% since April 2, according to Morgan Stanley. Shopping-center REITs are down 16.4%, while office and industrial REITs fell 12.4% and apartment REITs dropped 8.5%. Health-care REITs decreased 16.7%.

"The health-care sector is one sector where there are very attractive opportunities," said Keith Pauley, managing director at LaSalle Investment Management Securities in Baltimore, which manages about $3.5 billion of publicly traded REIT securities on behalf of institutional investors. He likes companies such as Healthcare Realty Trust Inc., of Nashville, Tenn.; Ventas Inc., of Louisville, Ky.; and Health Care Property Investors, Newport Beach, Calif., which he credits as companies that can ably cover their dividends and whose underlying businesses are improving.

"The fact that the health-care companies have fallen like other higher-yielding REITs that aren't covering their dividends makes them more attractive," he says.

"Retail REITs still have the most-visible earnings growth over the near term," said Tim Pire, portfolio manager at Heitman Real Estate Securities, in Chicago, which manages about $2 billion in assets. He cited continued healthy consumer spending, limited new construction and strong demand from retailers for new store locations. "From an earnings perspective, that group will have some of the best earnings growth from 2004 and 2005," he said.

Mr. Pire recommends investors look at REITs such as Mills Corp., of Arlington, Va., and General Growth Properties Inc., of Chicago, which have experienced two of the biggest recent declines in the retail group. "They are pretty solid companies with good prospects going forward," he said. "It's an interesting time if you can find some high-quality names and high-quality management teams where price has declined. It would be a good time to look at those names." He cites office REIT Boston Properties Inc., of Boston, as another example of a company with those characteristics.

Tony Howard, an analyst with Hilliard Lyons in Louisville, Ky., recommends investors take the time now to concentrate on more economically sensitive REITs such as apartment, industrial and office REITs. "They should do better with an improving economy," he said.

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