REITs Gain Momentum Among Commercial Investors, Practitioners

REITs are emerging as one of the fastest-growing economic sectors in U.S. public markets. Should you get involved?

October 1, 1996

They have been called a new frontier for commercial properties.

With assets exceeding $120 billion, real estate investment trusts (REITs) are emerging as a dominant force in the commercial market. And they're changing the way real estate investment is regarded on Wall Street and Main Street.

''I think there is a significant paradigm shift in commercial real estate,'' says Gary Ralston, CCIM, president of Com-mercial Net Lease Realty, Orlando, Fla., a $400 million REIT that owns nearly 200 retail stores. ''REITs are here to stay. They're going to be major equity owners in the market.''

REITS were created in the 1960s as a way to give small investors the opportunity to partake in large-scale real estate deals. But the market for REITs--corporations or trusts that use investor capital to acquire or provide financing for real estate--has taken off in recent years because going public has enabled companies to raise money and overcome the credit crunch that dogged the late 1980s and early 1990s.

Shares of most REITs are publicly traded; there are more than 200 listed on stock exchanges, according to the National Association of Real Estate Investment Trusts. The most common type is an equity REIT, which uses capital from investment to buy and develop such real estate as apartment and office buildings, shopping centers, and industrial properties.

Mark Decker, president and chief executive officer of NAREIT, Washington, D.C., believes REITs will own about 10 percent of commercial real estate--about $300 billion in assets--in the U.S. by the turn of the century or soon after.

''Commercial real estate companies operating as public REITs will end the boom-and-bust cycle of commercial real estate,'' Decker says. ''REITs bring a lot of stability and predictability. They're going to keep the supply and demand of commercial real estate in far greater balance than anything we've ever seen historically.

''It's the dominant commercial real estate market today, and increasingly it will be what commercial real estate is in the U.S. for investors.''

When a REIT profits from a real estate deal, says Decker, so do its shareholders. Rental income and gains on sales of property are reflected in the REIT's price per share or passed on as quarterly dividends. Under federal law, REITs are required to distribute 95 percent of taxable income to shareholders.

''For a broker who wants to sell an apartment building to a REIT, know who the REITs are locally and nationally, talk with acquisitions officers [at these companies]to see whether they're interested in owning. REITs generally have tremendous access to capital on short notice, so they're good to deal with,'' says John Magnuson, CPM'', a former president of the Institute of Real Estate Management and an investment adviser to REITs. ''They're willing buyers because they have cash on hand and have to keep money invested. It's a fast closing.''

Decker says commercial practitioners would be wise to ''get to know the management of these companies.''

''For commercial brokers and all who are involved in the financing and selling and buying of commercial real estate, this is the industry they will be selling properties to,'' he says. ''Their future will be tied very closely to REITs because REITs will be the dominant buyers of real estate.''

Like any other investment, REITs carry risk and should be researched from an investor's point of view.

''With a REIT, you own shares in a business. You don't really own a property,'' says James Webb, a professor of finance at Cleveland State University and the executive director of the American Real Estate Society. ''That means it's highly dependent upon the management and the philosophy of a company.

''You're dealing in a business sphere to a greater extent than a single piece of property. If you don't like the management of a property and you own it, you can fire'' the manager, he says. ''With a REIT, you have no control. On the other hand, you have liquidity in a REIT; you don't in a [privately owned] property.''

Ralston says it's critical that commercial practitioners investigate a REIT through annual reports, security filings, proxy statements, or a prospectus to learn about its holdings and strategy.

''If a commercial real estate broker is going to try to sell property to or from a REIT, it's important to know the company just as you would any client. These companies are focused on a particular specialty in real estate,'' says Ralston, adding that REITs typically own buildings in the same industry, such as a host of hotels or a number of apartment complexes.

''It means if you're going to deal with a company like this, you need to elevate your expertise,'' he says. ''You need to know what the company is looking for, how you can serve this customer. Be well acquainted with what it owns and its strategic direction.''

Carole Fleck is a former senior editor for REALTOR® Magazine.

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