REITs' Future Looks Bright

September 1, 1999

Two years ago, real estate investment trusts were so hot that some brokers were saying to prospective buyers, “If you’re not a REIT, don’t even talk to me.” Everyone thought REITs would be growth vehicles forever, sidelining traditional real estate entrepreneurs, pension funds, and other private equity investors.

Of course, 1998’s dismal stock market performance radically changed the playing field. But people who think REITs aren’t active these days are missing the boat.

REITs need to grow. Moreover, they need to sustain the spread between their competitors’ growth rate and their own. If they can grow faster than their peers, they can attract capital--and, more important, not lose investors or jeopardize stock price.

Today, REITs are looking for new strategies to achieve their growth objectives, including accessing private and public equity capital; using secured and unsecured debt; issuing preferred stock; pursuing off-balance-sheet joint ventures, strategic mergers, and consolidations; and acquiring core and noncore assets in the United States and overseas.

REITs are also significant disposers of real property. Our data shows that they have recently outsold pension fund advisers on a dollar-for-dollar basis, and the advisers have been very active sellers.

It’s true that trusts are doing less buying; their first quarter 1999 acquisition rates were only 20 percent of the rates for the same period last year. Instead, they’re moving toward development and rehabilitation, where they feel they can still engineer growth and increase funds from operation. It’s better to sell off an asset that has reached its maximum use and purchase one at the bottom of its growth cycle that can be repositioned.

In addition to attracting new capital, REITs will have to continue to replace the capital they have in place. Keeping investors is a challenge, because institutional investors typically sell out their positions every three years. To attract and keep investment, REITs must stay on the move, which means transactions--which means opportunity for brokers.

In order to add value, brokers have to understand not only how to bring a buyer and seller together but how to obtain capital and the financing as well.

Over the next year or two, I don’t see anything that will cause REITs to suddenly be rediscovered as growth vehicles. Long term, however, the outlook is spectacular. The closer we get to 2010, the more attractive REITs are going to be to both pension funds and individual investors. As baby boomers get older and start to access pension benefits, pension fund cash flows are going to be negative. Boomers close to retirement are going to look for stocks that can generate both income and growth. REITs are wonderful vehicles for that.

Also, the global population is growing at a healthy clip, so there’ll continue to be a need for new buildings. But the growth market will be overseas, which will create new challenges for REITs and the brokers who serve them.

Finally, REITs will continue to expand into uncharted territory. To remain competitive and continue to grow, they’ll have to go further out on the risk curve, which for some will mean going down in property size and market size.

REITs are here to stay, and toward the end of the year, we should see them accelerate their acquisition activity. But the nature of their business is changing dramatically, so hold on to your hat. It’s going to continue to be a wild ride.

Geoffrey Dohrmann is cofounder and CEO of Institutional Real Estate Inc., Walnut Creek, Calif. He’ll speak at TRANSACT ’99 at a session titled “REITs: Challenges of Operating in a Mature Real Estate Environment.” He can be reached at geoffrey.dohrmann@irei.com.

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