Once fixer-uppers, real-estate funds shine

The smiles are back.

After two years in the price doldrums, investors in shares of Real Estate Investment Trusts (REITs): publicly traded companies that buy, manage, renovate, and maintain income-producing properties, are grinning cheerily.

So are the managers of REITs and of mutual funds that invest in these real-estate companies.

"I'm feeling good," says David Lee, portfolio manager of T. Rowe Price Real Estate Fund. "It is nice to be able to reward our patient shareholders."

"The last six or seven months have been a much happier period," says Steven Wechsler, president of the National Association of Real Estate Investment Trusts.

Average prices of shares in the 199 REITs in the United States - shares traded on the major stock exchanges - sank 6.5 percent in 1999 and 18.8 percent in 1998.

So far this year, they are up about 13 percent.

"Hoo-wah," exults Ralph Block, REIT portfolio manager at Bay Isle Financial Corp. in San Francisco. Shares in his fund, Undiscovered Managers, have risen about 17.9 percent so far this year. He anticipates another 4 to 5 percent by the end of 2000.

The real-estate business underlying REIT stocks is in good shape this year, as it was last year. But share prices don't always follow the business.

"Market psychology is so important," he says.

As a group, the 63 mutual funds investing in REITs went up a bit more than the average REIT in the first six months - 17.1 percent on average, according to Morningstar, a Chicago firm that tracks mutual funds.

In the second quarter, REITs were the best performing mutual fund group after those that specialized in health and sciences.

With dotcom stock prices descending and major stock indexes stagnant, some investors are looking for investments that are more conservative, more grounded in reality, less hyped.

REIT shares did extraordinarily well between 1996 and 1998. With a return of 35.7 percent in 1997, they quickly attracted the attention of growth and momentum investors - those seeking large returns in a hurry. They are "the wrong type of investor," says Mr. Lee of the Baltimore-based T. Rowe Price group of funds, managing $170 billion.

When earnings growth of REITs slowed a bit, many growth investors fled for technology stocks or other greener fields.

As a result, the price of REIT shares declined to the point last year where their assets - the office buildings, rental apartments, hotels, industrial facilities, shopping centers, self-storage facilities, and other real estate they own - were worth more than the value of their total shares.

REIT shares, in many cases, were being traded at a 25 to 30 percent discount from net asset values, recalls Louis Taylor, an analyst with Prudential Securities Inc., in New York.

It made sense for REIT managers to sell some properties to other real-estate investors, such as pension funds and private firms. The managers then used the cash to buy back their own shares and boost the depressed prices a bit.

Even now, after the recent climb in prices, REIT shares are priced at an average 10 to 15 percent below their net asset value, various experts reckon.

So are real-estate mutual funds still a good deal?

Those in the industry reply with one voice, "Yes," but with varying shades of enthusiasm.

Mark Howard-Johnson, portfolio manager of the $165 million Goldman Sachs Real Estate Fund, says: "The fundamentals of the real-estate business are as good as they ever have been."

"The easy money has been made," says Lee. "But REITs can continue to exhibit good gains."

"By no means are REITs expensive," says Steve Buller, portfolio manager of the $800 million Fidelity Real Estate Investment Fund in Boston.

REITs are selling on average for about 8.5 times their Funds from Operations (FFO), somewhat equivalent to the earnings per share of other stocks. The price to earnings ratio of many other stocks are above 20.

REITs offer a dividend yield of more than 7 percent. That's far better than the paltry 1.1 percent dividend yield on the Standard & Poor's 500 Index.

It also beats the 6 percent coupon on a 10-year US Treasury bond.

Moreover, with low vacancy rates and no overbuilding of offices and rental apartments in sight in many markets, including such major cities as Boston, New York, and San Francisco, mutual-fund managers anticipate an increase in REIT rental revenues as leases expire in the years ahead.

REIT dividends are "secure, but not guaranteed," says Lee.

Paul Reeder, director of REIT research at SNL Securities, a data-gathering firm in Charlottesville, Va., worries that too many investors will pump up REIT share prices too much.

"We don't want to go that route," he says. "But we seem to be suddenly back in fashion."

"You shouldn't be in real-estate securities if you aim at making 50 to 100 percent," says Mr. Buller. He figures 10 to 15 percent return per year is right - "which is not bad."

(c) Copyright 2000. The Christian Science Publishing Society