REIT Stocks Offer Better Value Than Properties

To date, only Monmouth Real Estate Investment Corporation and Parkway Properties have announced investment programs for REIT securities, the former in late 1998 and the latter early this year.

"When REIT securities yield 25 percent more than properties and when real estate assets are purchased in REITs at a 25 percent discount from private market prices, the argument for purchasing securities as an investment substitute for real properties is compelling," asserts Eugene Landy, Chairman and Chief Executive Officer of Monmouth. "We are investing up to 15 percent of the portfolio ($15 million to $20 million) in real estate securities, but at the same time increasing the property portfolio because Monmouth is not an investment company."

Parkway Properties has allocated $40 million to its REIT Significant Value Program and begun purchasing the stock of other real estate investment trusts. "The best value in real estate that I see today is in the public sector," states Steven Rogers, President and Chief Executive Officer. "The capital markets have devalued REITs, which we can now buy with high sustainable dividend rates and a 10 percent-12 percent cap rate plus a good internal rate of return. In a nutshell, we're trying to buy good assets cheaply."

Investment Strategies Differ

Landy focuses on common and preferred stocks in companies that he knows well and that have a high payout. When asked what qualifies him to pick real estate securities, he replies, "Not a great deal of expertise is needed because of the high discounts to net asset value prevailing across the industry."

In contrast, Parkway has a formal strategy that focuses on common stock in compatible companies that meet defined investment criteria, including a strategic fit and an opportunity for Parkway to add value. "We intend to apply the same discipline to our evaluation and purchase of REIT securities that we have historically employed in the fee simple purchase of office properties," says Rogers."

Analysts Are Cautious

"When capital is scarce, the onus is on management to show that this is the highest and best use for available capital," stresses Dan Pine, senior vice president and portfolio manager, Alliance Capital. "I'm not convinced that this is the right thing to do. For small REITs, where the float is thin, it may seem preferable to buy other companies, but they don't get the benefit of accretion forever that they'd get from buying their own stock."

For Jon Fosheim, principal and co-founder, Green Street Advisors, "It typically would not make sense to buy the shares of other REITs if your own shares are trading at a big discount to net asset value. And it's dangerous if the business isn't compatible with your own and management isn't prepared to be proactive. But Parkway's price is not terribly far off its net asset value and its management team has a track record of being pro-active shareholders, so we might give them the benefit of the doubt."

Pine thinks that "the risk of a non-operating capital loss is not being factored into thinking on this subject; such losses could contribute to undermining the credibility of the industry." And Thierry Perrein, Vice President, Donaldson, Lufkin & Jenrette, points out that REITs already owning shares in other REITs have not yet realized their paper capital losses, and that it can be difficult to analyze REITs that have invested in REITs owning other property types.

Recent examples of such investments are scarce, so it's hard to generalize. Analysts point to Developers Diversified's 1998 stake in American Industrial Properties as difficult to understand. HRPT Properties' stakes in spinoffs Hospitality Property Trust (1995) and Senior Housing Trust (1999) mean that the company effectively owns several property types. Simon Property Group's 1997 investment in Chelsea' GCA Realty's stock was part of a strategic alliance agreement that remains in force and is thus unremarkable. National Health Investor's 1998 investment in LTC Properties also appears compatible.

Weak Industry Pricing a Window of Opportunity?

With tech stocks recently sliding toward a bear market, REIT stocks may begin a steady recovery. If that happens, REITs may have a window of opportunity to enhance shareholder returns by investing in the stocks of other REITs. Over the next few quarters, we could see increased use of such investments to enhance returns or as preludes to mergers or takeovers. The stock market may be offering a relatively inexpensive way to continue the industry's ongoing consolidation.