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All About REITs: You Ask, We Answer

TSC REIT Roundtable panelists answer readers' questions about reporting income for REITs and more.

At last week's

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REIT Roundtable, we put some of your questions to our panel. Here's a look at a few of the questions and the winners of those coveted

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T-shirts.

There's Just No Comparing Those REITs

Will there ever be a consistent method for reporting income for REITs? It's not that complicated, but most SEC filings are still difficult to compare. -- Steve Horwitz

Steve, many REIT investors feel the same way. As we've discussed

before, funds from operations is the standard earnings measure for real estate investment trusts. In its simplest form, the calculation is net income minus real estate depreciation expenses. Because REITs use many different depreciation and capitalization methods, however, the measure of FFO isn't consistent across property sectors or even companies.

The National Association of Real Estate Investment Trusts

has begun a process to standardize the calculation in hopes of clearing up the confusion and, in some cases, abuses. NAREIT's proposal would eliminate the use and abuse of one-time events to inflate FFO; include gains and losses from all asset sales in FFO; and redefine the depreciation and amortization add-back to more closely reflect real estate operating costs.

Although those changes would go a long way toward standardizing FFO, some analysts say NAREIT is too immersed in the industry to provide an objective review. Nonetheless, one member of the roundtable feels this is a big step in the REIT maturity process. "Improving REIT reporting standards and leveling the playing field will be a force for the real estate world in the new millennium that may help avoid the dark side of investor flight seen in 1998," says

Legg Mason

's Glenn Mueller, borrowing some lingo from filmmaker

George Lucas

.

Capital Discipline

My perception is that any advance in REIT prices will be promptly lost -- and worse -- by investment bankers pumping more REIT issues into the market. Can a serious case be made that I'm wrong in this perception? -- Charles Blankstein

Well, Charles, if history is any judge, the capital train should be leaving the station any day now. But this time it may be different. For investors' sake, let's hope so.

The general feeling at the NAREIT conference was that REITs got last year's message -- don't abuse equity capital -- loud and clear. "The markets spoke last year," says Ron Gibson, CEO of

Highwoods Properties

. "We won't be issuing equity anytime soon."

Many REITs even indicated a desire to become self-funding -- to be able to grow internally and fund any acquisitions or development through property sales and internal cash generation.

Although total self-funding in real estate is nearly impossible, many analysts welcome the fact that REITs are willing to try. Indeed, one Roundtable member thinks the ability of REITs to fund growth from internal sources will segregate winners and losers. "A number of REITs appear well positioned to perpetuate growth without the need for external capital," says

Donaldson, Lufkin & Jenrette's

Larry Raiman. "

However, others may be feeling the pinch of capital constraints. This contrast should manifest itself in REITs separating from one another, some maintaining a strong financial footing, while others

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are forced into involuntary liquidations to meet capital calls."

No doubt, some REITs will use the recent spring stock rally to issue equity. But REITs have matured since last year, making it less likely that investment bankers will be able to cajole companies into issuing shares without a specific, accretive objective in mind. Look for most REITs to seek capital only for new developments that are clearly accretive to profits going forward. Beware of those that don't.

The Rate Game

If interest rates go up, how will REITs fare? Will they have to raise their dividends to remain attractive to investors? -- Subodh Nijsure

As interest rates increased over the past several weeks, REITs have held their own, and many analysts think REITs are a good place to be in a rising rate environment. "I think it's a misperception to many that REITs, as a result of their high dividends, trade like bond equivalents," says Ritson Ferguson of

CRA Real Estate Securities

. "I'd much rather be long real estate and real estate stocks in a growing economy and the possibility of a slight increase in interest rates than in an environment with lower rates and the fear of recession."

Chris Marinac of

Robinson Humphrey

is studying REITs in a rising-rate environment. When rates increased in 1994, for example, Robinson Humphrey's REIT universe had a total return of 3.5%, while the

S&P 500

rose only 1.3% and the

Lipper Growth & Income

index lost 0.7%. "A quick look at some supporting data suggests REITs can weather a higher rate environment," says Marinac. (We'll keep you posted on his ongoing research.)

Carl Tash of

Cliffwood Partners

also believes most REITs can weather a slow-rising rate environment, but recent rapid rises in the 30-year Treasury bond could put the brakes on the rally. "I'm concerned that if we get economic data that's too strong, REITs are likely to break

below 310 on the

Morgan Stanley REIT Index

first, before they move up again," he says. He also points out that rising rates increase refinancing risk for REITs with maturing debt.

Congratulations to Steve, Charles, and Subodh, the winners of

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T-shirts for their compelling questions. A T-shirt also goes to Kevin Grehan, who asked about the impact of e-commerce on REITs, which will be the subject of an upcoming Building Blocks.

If you have a question about REITs, shoot me an

email . I'll do my best to feature it in an upcoming column.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback at

invest@cjnetworks.com.