As the takeover battle over Equity Office Property ( EOP ) demonstrates, real estate investment trusts have never been hotter. At $54 per share, the latest bid from the Blackstone Group exceeds $38 billion, which would qualify as the largest buyout on record.

REITs are just as popular with smaller investors: IPOs and secondary offerings in the sector approximated $18 billion in 2006, the highest activity level since $26 billion in 1997.

Mutual fund investors have also benefited as funds that specialize in REIT funds have also been hitting new highs. The 90 of the largest mutual funds with a real estate focus have returned an average 5% so far this year. That comes on the heels of an average return of 35.8% in 2006, an annualized 26.7% over the last three years and an annualized 24.5% over the last five years. Any way you look at it, REITs have been one of the best ways to build wealth and add diversification to a portfolio this month -- and over the last few years.

Those who prefer to hold individual stocks should consider four companies that get top marks from Rating's models in each of the subsectors of this industry: office properties, regional malls, health care and apartment REITs.

Since it's too late to get in on EOP...

Our first pick is SL Green Realty ( SLG), which has a market cap of $7.9 billion and is up 9% year to date. Across the country, office REITs, which have performed sluggishly in recent years, are finally benefiting from lower unemployment rates and lack of significant land and building supply in most areas.

SL Green Realty is a pure play on New York City. It owns 29 buildings with over 17 million square feet located on the avenues and major cross streets of midtown Manhattan near the key transportation hubs. Over the last year, New York office rents have risen by 20% to 35%, with tenants paying $80 to $100 per square foot in a supply-constrained market.

While rents are somewhat lower in other parts of the New York metro area and in further-out suburban areas, demand from a broad range of industries, especially financial services, remains strong. With a low and falling vacancy rate of 3% to 5%, the outlook for rents to rise again in 2007 is favorable.

New acquisitions have added flexibility and scale. Last Friday, SL Green completed its $6.0 billion acquisition of Reckson Associates Realty ( RA), adding six premier office buildings in New York City encompassing about 5.6 million square feet. The company also acquired about 3.6 million square feet of top-tier commercial office space in New York's Westchester County and in Connecticut.

And on Tuesday, it announced the sale of some of its older properties, which will generate cash to pay down debt associated with the recent acquisitions. This series of transactions will make SL Green the third-largest office REIT on the basis of market value.

Our second REIT pick is consumer-related. The largest play in this area is Simon Property Group ( SPG), which has a market cap of $24.2 billion and is up 12% year to date. Retail malls are a bet that the economy will remain solid and consumer confidence high this year. Retail sales growth, while slower, should continue to generate demand for retail space, pushing rents higher. More stable energy prices and a steady interest rate environment could also aid the sector.

Simon owns a full spectrum of regional malls, which generate about 77% of its net operating income. The remaining 23% comes from other properties, such as its premium outlets, community and lifestyle centers as well as shopping centers in France, Italy, Poland, Japan and Mexico.

Simon's funds from operations increased by 9.4% in the third quarter to $369.5 million, and FFO-per-share rose by 9.2% to $1.30, due to strong performance in core operations and acquisition activity. Management has raised its guidance for full-year 2006 results; it now sees FFO at $5.36 a share and expects earnings per share of $1.86, up 67.3% on the year. It reports on Feb. 2.

Those interested in a little higher yield than the common stock offers might consider one of the company's three classes of preferred stock: the 7.89% Series G Preferred Stock ( SPG-PG) the 6.00% Series I Preferred Stock ( SPG-PI) or the 8.375% Series J Preferred Stock ( SPG=PJ ).

Our third pick is another acquisitive company, Health Care Property Investors ( HPC). It is the nation's largest health care REIT, with a market cap of $6.5 billion. It is poised to benefit from U.S. demographic trends as well as increased attention to health care by the new Democratic Congress, as I outlined in a recent article .

Earlier this month, Health Care Property Investors took advantage of the hot market to issue 6.7 million shares of common stock; the proceeds will be used to pay down some of the debt the company issued to fund its $5.3 billion acquisition of CNL Retirement Properties. The deal, which was the largest ever in the health care sector of the REIT market, adds upscale retirement properties to Health Care Property Investors' portfolio, diversifying its revenue streams. The combined entity now has over 717 properties in 44 states.

The health care real estate business is highly fragmented, and there are not enough new units being created to meet rising demand. Since public health care REITs are still a relatively small part of the investment landscape, Health Care Property Investors is well positioned to participate in the industry's consolidation by acquiring a wide range of assisted living communities, health care facilities and medical office buildings.

In the meantime, the stock pays an attractive 4.2% yield and offers exposure to one of the most attractive long-term growth industries. Full-year results are expected on Feb. 12.

For those who can't resist apartments, our fourth pick is AvalonBay ( AVB), which is up 14% year to date and which hit a new high last week. Condo markets in many parts of the country, such as Florida, have been bid up by speculators, creating a danger that units that can't be quickly turned around will be converted into rentals. But current indications are that a gradual decline in inventories of homes for sale and average residential selling prices will help some of these easy-credit excesses get worked off.

And AvalonBay has avoided overheated markets such as Florida, focusing instead on markets where apartment units and single-home prices are high, factors which tend to boost rents. It holds stakes in 167 apartment complexes in 10 states and the District of Columbia.

AvalonBay just raised $594 million through a secondary offering of 4.6 million shares, boosting its liquidity and supporting future growth. The company was also recently added to the S&P 500, making it a "must" holding for index funds. It expects 2007 earnings per share to be between $3.66 to $3.90 and 2007 funds from operation to be in a range of $4.68 to $4.92. That would represent an increase of 8%-10% over expected 2006 results, which should be released on Feb. 1.

Finally, for the more aggressive investor who is willing to commit for the longer term, there are long-term options available on two of our picks, SL Green and Simon Property, that can be used in various investment strategies.

Four REITs That Get Top Marks

Rudy Martin is the director of research for Ratings. In keeping with TSC's Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

In keeping with TSC's Investment Policy, employees of Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.

While Martin cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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