BUT THEN, WHAT’S DOWN MAY GO UP. . .: IT ISN’T TIME TO BEAT YOUR FEETS FOR REITS

Real estate investment trusts aren’t likely to recover anytime soon from the nasty spill they took late last year.

But a few analysts are calling on investors to jump back into the sector to take advantage of what they say are low valuations and depressed prices.

In January, PaineWebber Inc. analysts advised investors to “back up the truck and buy (Patriot Hospitality and Starwood Hotels) on weakness” resulting from a proposal by the Clinton administration to attack the paired-share REIT structure. They argued that the relatively low valuation of both REITs did not reflect the value of the paired-share structure or the growth each company is expected to achieve in 1998 and 1999 – about 30% to 40% per year.

Paired-share REITs, under a grandfather clause, are permitted to run operating companies and, thus, protect most of the profits from those companies from corporate income taxes.

Merrill Lynch Likes ’em

One of the most ringing endorsements of REITs came just last week when analyst Eric Hemel of Merrill Lynch & Co. – the lead investment banker for many of the largest REITs – argued for a “radical overweighting” of REIT stocks.

Despite their poor performance this year, REITs, as measured by valuations, are dramatically cheaper relative to the S&P 500 stock index than at any time during the last four years, says Mr. Hemel.

He says REITs, given their strong dividend payouts – about 6% vs. 1.5% for S&P 500 stocks – and an estimated 9.5% growth rate in “funds from operations” during the next five years, are a relatively safe bet in a lofty stock market.

(Funds from operations is a performance measure based on net income, excluding gains or losses from sales of property or debt restructuring, and adding back depreciation of real estate.)

“We rarely take positions on whether investors should overweight or underweight REITs in an equities portfolio,” says Mr. Hemel. “But in light of today’s valuations, we are departing from tradition.”

But the
recommendation may be too bitter a pill for many investors, especially when the broader market continues to hit record highs.

REITs are down 3.36% for the year-to-date period ended March 20, compared to a return of 13.65% for the S&P 500 index, according to SNL Securities in Charlottesville, N.C.

The sector took a nose dive late last year when investors began getting nervous about high valuations. and the ability of REITs to sustain high levels of earnings growth with real estate prices peaking in many markets, making acquisitions very expensive.

The sector has also been dealt a blow by concerns about overbuilding and the effect of federal legislation that might squash some of the tax advantages of the four giant paired-share REITs – Starwood Hotels, Patriot American, First Union Real Estate Investments and Meditrust Corp. -and the so-called paper-clip REITs that emulate the pair-shared structure.

“We see a lukewarm year at best,” says E. Chandler Spears, director of research at SNL Securities. “There will be some success stories in the midst of all this, but it will be a tough year for REITs in general.”

on the other hand. .. .

But some real estate funds are already heeding the advice of bullish analysts and ratcheting up their stakes in certain battered REITs.

The $45 million CRA Realty Shares fund, for instance, has increased its investment in Starwood to 4.8%, its single largest holding, from about 3.5% at the end of last year. The no-load fund was down 5.28% year-to-date as of March 19, while its peer group was down 2.40% for the same period, according to Lipper Analytical Services Inc. in New York.

“Even with the proposed legislation, the stock looks awfully cheap,” says T. Ritson Ferguson, president of Radnor, Pa.-based CRA Real Estate Securities, the fund’s adviser.

He says even if Congress passes the legislation, paired-share REITs could split into separate companies – one that owns and another that manages properties – and the stock price of each is likel
y to exceed that of the combined entity.