A REIT Primer, Part III

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Remember that first apartment -- cozy, damp, leaking faucet in bathroom, walls made of cardboard? Gosh, the memories are so clear, I can smell them. Even college apartments have come a long way since then. Not only for those experiencing the best four years of their lives, but also for investors.

It wasn't that long ago that multifamily apartment complexes were either family-owned businesses that limped along on depreciation value or were wrapped up in the now-infamous real estate limited partnership that provided tax breaks for high-income taxpayers. Regardless, the capital structure was such that little pride was placed into improving property and its surroundings.

Enter the real estate investment trust. As discussed in

Part I of this series, the structure of REITs makes it attractive for developers and shareholders alike to focus on developing quality real estate property. The REIT structure provides favorable tax treatment to developers (no corporate income tax if income is passed through to shareholders) and a nice income opportunity for investors looking for an "equity income" alternative to utilities and traditional fixed-income securities.

In

Part II we looked at REITs that specialize in the retail properties -- malls and strip centers. In this installment we take a look at some REITs that can put a roof over your head, and, possibly, a dollar in your pocket.

While many REITs specialize in the multifamily housing sector, none has done it quite as long as

New Plan Realty Trust

(NPR)

. A New York based multisector REIT, New Plan also develops and manages shopping centers and outlet centers. However, we include New Plan in the multifamily area as a result of its commitment to continuing its rapid growth into the garden apartment market. New Plan is the granddaddy of REITs, having been in the real estate business since 1926. In addition, New Plan's dividend history is impressive. The current period will mark the 75th consecutive quarter in which the company has increased its dividend. The stock yields just under 6%.

As attractive as the yield is the success of the company's conservative growth strategy. Last year, the company looked at over 2,500 potential property acquisitions, completing about 30, almost all of which proved immediately beneficial to New Plan's funds from operations (FFO, the measure of profits from a REIT). In the past year, revenues have grown just under 30% and FFO has increased almost 20%. In that time the company has almost doubled its apartment units, continuing to focus on garden style, upper-end complexes. New Plan also has relatively easy access to additional capital at below-average costs, a result of its strong balance sheet and rich operating history.

The company will never pay the 8% or 9% of some riskier REITs. However, the strength of management, its properties and risk controls all bode well for New Plan as a core, conservative holding in a portfolio of REITs.

If New Plan is the granddaddy of REITs,

Equity Residential Properties Trust

(EQR) - Get Report

is the "big daddy." Equity Residential owns more than 400 apartment properties with over 140,000 units across over 30 states. Well-known financier

Sam Zell

controls the largest multifamily REIT in the U.S. Like New Plan's management, Zell has a world of experience in real estate development and has put his reputation and knowledge to work for his shareholders. The company almost doubled the number of owned units in 1997, largely through acquisitions of other REITs and small real estate developers.

The company also has continued to increase its dividend, raising the quarterly payout to 67 cents per share, up from 62.5 cents. At the current $51 price, the stock yields just over 5%. The dividend appears very safe from our view, as continued acquisitions and operating revenue more than cover the payout. Additionally, the steady dividend should continue to provide good downside protection in volatile markets.

Also like New Plan, Equity Residential has economies of scale and operating history working to reduce its cost and ease its access to expansion capital. As the largest multifamily REIT, the company has operating efficiencies its competitors lack. Additionally, the company's geographic diversity provides nice protection from economic downturns in any specific region of the country.

While the price appreciation potential of any REIT is uninteresting when compared to more dynamic industries, investors looking for stability and steady growth will do well to consider companies like Equity Residential Properties Trust as a holding.

An up-and-coming company in the multifamily sector is

BRE Properties

(BRE)

. Formed in 1970 and successor to

BankAmerica Realty

, BRE properties has undertaken a rebirth as it works to become the pre-eminent player in multifamily housing in the Western U.S. The company has sold more than $200 million in noncore assets over the last year and redeployed those funds into multifamily acquisitions, including

TrammellCrowe Residential

.

The company owns more than 21,000 housing units in 12 states, primarily west of the Continental Divide. Many of BRE's markets can be found on the list of fastest-growing metropolitan areas, including Las Vegas, Salt Lake City, Portland, Seattle, and the major California markets. The acquisition of TrammellCrowe added almost 8,000 units as well as very profitable construction and rehabilitation expertise that was previously contracted out.

BRE's financial strength remains evident as the company increased its lines of credit from $30 million to $150 million while reducing the applicable rates of interest. The company's financial flexibility is further enhanced by its increasing ability to retain earnings for investment and general corporate purposes: In the last year, the company's FFO growth has enabled it to raise the dividend two times, for a total increase of 9.5%.

Unlike New Plan and Equity Residential, BRE does assume greater geographic risk. A general slowdown in the economies of the Pacific Coast states could hamper growth. Additionally, one should consider the shaky ground on which the company sits. With 58% of the company's holdings in California, earthquake damage is a risk. The company has recently increased its insurance to a limit of $60 million.

At a current price of just under $28 a share, BRE has a current yield of just over 5%, which appears safe under the current operating scenario. We look for slight dividend increases in the year ahead, as the company benefits from the synergies of the TrammellCrowe and other acquisitions.

Other regional multifamily housing REITs that deserve a look include

Associated Estates Realty

(AEC)

(Great Lakes region),

Colonial Properties Trust

(CLP)

(Southeast),

Gables Residential Trust

(GBP)

(Southwest) and

Charles E. Smith Residential Realty

(SRW)

(Washington, D.C. area). Nationally, one might look at

Camden Property Trust

(CPT) - Get Report

for a higher-than-average yield, although the company's leveraged balance sheet remains a concern.

All multifamily REITs share the risks of property depreciation and the need for capital intensive renovations in the event of natural disasters or general tenant abuse. In addition, the real estate market is cyclical and, in times of economic slowdown, the multifamily market can suffer from slower growth and property devaluation, sometimes more significant than other sectors. Ready access to capital can also be a risk for REITs, especially those less established companies.

In the next installment: a look at hospitality REITs.

*****

Building Blocks:

The

National Association of Real Estates Investment Trusts

released its annual statistics for the industry late last week.1997 was a record year for REIT capital development as $45 billion in REIT securities were offered, including 26 IPOs raising just over $6 billion. The market cap of the 210 publicly traded REITs was over $141 billion at the end of last year, compared with only 142 companies and $16 billion five years ago.

I received a rather harsh commentary on my upbeat comments on

Kranzco Realty

(KRT)

last week from a savvy REIT fund manager. He argues that Kranzco engineers its balance sheet each year with property acquisitions and other "shifting" to produce the numbers and the payout each year. The comment suggested that Kranzco has seen declining occupancy and net lease rates over the past several years. Bottom line: His suggestion was that REITs should be judged from a total return perspective rather than a simple income perspective. His suggestion is a good one and one utilized in this analysis. However, the yield on Kranzco is fairly compelling, even if cut by 20%. Check it out yourself.

Christopher S. Edmonds, a contributor to TheStreet.com, is vice president and chief market strategist for The Guardian Trust Company, a Topeka, Kan., asset management concern. He currently holds long positions in New Plan Realty. He invites your feedback at

csedmonds@gtrust.com.