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The building was bought through a program sponsored by Triple Net Properties of Santa Ana, Calif., one of a growing number of companies that put together so-called tenant-in-common deals, which are now competing for prime office and apartment buildings and shopping centers with publicly traded companies, pension funds and large private real estate companies. Robert M. White Jr., the president of Real Capital Analytics, said that sponsors of these deals are helping to drive up real estate prices. "They are not the only ones aggressively pursuing real estate, of course, but they are some of the most motivated buyers and they are a huge topic of conversation," he said. One of the newer ways of buying real estate, tenant-in-common programs, or T.I.C.'s, offer fractional ownership of large properties and are primarily aimed at people who have recently sold other commercial property and seek to defer capital gains taxes. Under Section 1031 of the federal tax code, such taxes can be deferred if the property being sold is exchanged for one of the same value. But the seller has to find a new property within 45 days and complete the exchange within 135 days after that - a deadline that sponsors say is often hard to meet, particularly in a hot real estate market. In 2001, there were $165 million worth of real estate deals involving tenant-in-common equity, but this year the volume is expected to approach $2 billion, according to Omni Brokerage Inc. of Salt Lake City, which tracks tenant-in-common properties sold as securities. The number of companies sponsoring such programs grew from nine to more than three dozen during the same period, said W. Rob Hannah III, the president and chief executive of TSG Real Estate of Chicago and the vice chairman of the Tenant-in-Common Association, a two-year-old trade group. The explosive growth of tenant-in-common investments, which are sold through financial advisers, has attracted the attention of NASD, the securities industry regulatory body, which is looking into how these programs are organized and marketed. "Any time we see that kind of stunning growth in product sales," said Mary L. Schapiro, the vice chairman of NASD, "you have to be concerned about how it is being sold." Unlike real estate investment trusts, which sell shares in portfolios of properties, sponsors of tenants-in-common investments sell interests in individual properties. The concept of tenancy-in-common as a way that two or more people can buy real estate together, with each having an undivided interest in the property, goes back to English common law. But it was only in 1994 that tenant-in-common properties were used as an investment vehicle for people who do not know each other. Credit for this innovation is given to William O. Passo, the chief executive of Passco Real Estate Enterprises in Irvine, Calif. Last year, in the biggest tenant-in-common deal so far, Passco bought the Puente Hills Mall in City of Industry, Calif., for $143 million. More recent deals involving T.I.C.'s include St. Louis Place, a 20-story office building in St. Louis, bought by Behringer Harvard Funds of Addison, Tex., for $30.2 million; and Indigo Creek, a 408-unit apartment building in Glendale, Ariz., bought by Evergreen Development of Santa Ana, Calif., for $34.6 million. Although tenant-in-common deals have been around for a decade, their current popularity can be traced to a 2002 document issued by the Internal Revenue Service, which spelled out some conditions that had to be met before the investments could qualify for a so-called 1031 exchange, said William Winn, the chief operating officer of Passco. "That legitimized the industry in the real estate world," he said. Until then, he said, "some sophisticated real estate people were sitting on the fence," not knowing whether the investments would pass muster with the tax agency. To qualify, the investment must have certain characteristics that differentiate it from a partnership: each investor must have the same ownership rights; no single owner or group of owners may have more control than any of the other investors; all major decisions have to be made by unanimous vote; investors must have the right to sell their interest but may have to offer it to the other investors first; and no more than 35 investors can participate. The I.R.S. action does not guarantee that every investment structured this way will be accepted as a T.I.C. rather than a partnership, said Louis S. Weller, a principal at Deloitte Tax. Sponsors say that tenant-in-common investments appeal to sellers of small buildings - an apartment house, say, or a drugstore - who may be nearing retirement age and no longer want the burden of managing a property. When T.I.C.'s were first offered, Mr. Hannah of TSG Real Estate said, a minimum investment could be as little as $100,000. "Now the norm is $500,000 up to $5 million or $10 million," he said. Passco, for example, is about to complete its $100 million purchase of the Village at Orange, a shopping mall in Orange County, Calif., with $42 million of the equity from tenant-in-common investments, Mr. Winn said. The minimum investment was $1.6 million, he said. Increasingly, tenant-in-common investments are drawing people who do not need a tax deferment but simply want to diversify their holdings, said Anthony W. Thompson, the chief executive and chairman of Triple Net Properties, which owns and manages 102 buildings. Of these, 65, valued at about $1 billion, were bought through tenant-in-common programs, Mr. Thompson said. But there is a steep price for owning part of a high-grade office building or shopping center. Brokerage fees combined with the profit and transaction costs of the sponsors can total as much as 25 percent of the equity invested, Mr. Hannah said. Some sponsors are making a profit of 15 to 20 percent by buying a property and then selling it to tenant-in-common investors, said Dean Macfarlan, the chief executive of Macfarlan Real Estate Investment Management, a company in Dallas that has arranged more than $60 million in tenant-in-common investments. The sponsor's profit should not exceed 7 percent, he said. Given these fees, investors need to calculate whether they are better off paying the capital gains taxes rather than buying a tenant-in-common interest, said Michael G. Frankel, the national director of real estate tax services for Ernst & Young. They also need to have their own adviser and not merely rely on the word of a broker, he said. Another concern in the tenant-in-common industry, brokers and sponsors say, is that some of these investments are being sold as real estate transactions rather than as securities. Sponsors who do not register tenant-in-common investments could be putting themselves and their investors at risk, said David Bayless, a partner at the law firm of Morrison & Foerster, and a former official with the SEC. "It's pretty clear," he said, "that these 1031 T.I.C. exchanges are almost always securities." Registering as a security requires sponsors to supply investors with thick documents with many disclosures, including how they keep records, how they are compensated, and whether conflicts of interest exists. Such private-placement securities may be sold only to investors with a net worth of $1 million or an annual income of $200,000. Cary Losson, the president of 1031 Exchange Options, a consulting company, said it was "terribly reckless" for sponsors to sell tenant-in-common interests as real estate. "They don't have to provide nearly the level of due diligence," he said. One company that sells tenant-in-common investments as real estate is For 1031 L.L.C., based in Boise, Idaho. Pete Johnson, the vice president for marketing at For 1031, said his investors get the same information his company executives see, including rent rolls, environmental reports and loan documents. "We encourage them to visit every property," he said. "We want them to kick the tires." The company, founded in August 2003, invests mainly in office properties valued at $2 million to $20 million, Mr. Johnson said. Mr. Macfarlan said investors needed to ask a lot of questions before they bought tenant-in-common interests to make sure, among other things, that the property was not overpriced and that it had a stable base of tenants. "Whenever you have an asset class that is gaining as much interest as this one," he said, "there are always going to be a lot of Johnnies-come-lately who begin to flood the marketplace with poor investments. Some people will get hurt."
The demand for English-speaking service workers in Bangalore is so high that GE as well as Infosys Technologies and Tata Consultancy Services are now looking outside major Indian cities to set up new call centers and other operations because they can't recruit enough college-educated people. The same is true in China. What does that tell you? Most of the best and brightest Indians and Chinese are already fully employed and are negotiating higher wages and benefits for their work. And since these Indians and Chinese aren't anyone's fools, they've been demanding -- and getting -- increasingly higher compensation. After all, these Web-savvy men and women just have to check the human-resources Web sites of Western companies to see what their counterparts are making. And indeed they have, as their rising compensation proves. Chinese wages for skilled talent and college-educated workers have been running up sharply in recent years. Middle managers in China are making about $9,000 a year (what I made in my first year in business journalism out of graduate school in the late '70s). While reliable statistics on Chinese engineers are hard to come by, it's a safe bet that they're making a multiple of that salary. One reasonable estimate has good software writers probably making around $20,000 a year in Shanghai. Ditto for many hot-shot programmers in Bangalore, India. Chances are good that the 8% to 10% annual GDP growth rate projected for India and China will increase domestic demand for the talents of engineers, designers, accountants, and other knowledge-industry types. As a result, wages will continue to rise. This is a significant development offshoring. Honest corporate managers will tell you that to make offshoring work, you need at least a 300% to 400% wage spread between American software writers, engineers, accountants, and call-center employees and their Indian and Chinese counterparts. Labor costs have to be very, very low overseas -- not just lower -- to compensate for time-shifting, managing over such long distances, and decreased productivity. In America's alarm over service-sector jobs being lost to Asia, what's often overlooked is the flexibility and liquidity of labor markets around the world. Global labor arbitrage is hard at work narrowing the international wage gap among educated workers. That may not be terrific for companies hoping to save costs by sending service operations overseas. But it's a good thing for Indian, Chinese -- and American -- workers -- and U.S. office landlords. In China's Cities, a Turn From Factories Labor Pool Shifts As Urban Workers Seek Better Lives By Peter S. Goodman Washington Post Staff Writer Saturday, September 25 Throughout the southern province of Guangdong, whose factories produce nearly one-third of China's exports, and in other industrial areas along China's coast, labor is suddenly wanting -- particularly the 18- to 24-year-old women who have become the staple workers of China's export trade. According to a recent report from the Ministry of Labor and Social Security, China's factories lack 2.8 million workers, 2 million alone in the prime manufacturing zone along the Pearl River Delta. It is not so much a labor shortage -- there are still tens of millions of peasants and former employees of the state-owned factories who need jobs -- as a mismatch between the cutthroat wage demands of the export trade and the rising expectations of Chinese workers. The government report blames the situation on poor working and living conditions, stagnant pay and chronic violations of China's labor regulations in the sprawling manufacturing towns that have based their growth on selling to the world market. Where once a paycheck, even under harsh conditions, was enough to entice tens of millions of people to leave their villages in China's interior and flock to factories on the coast, workers are beginning to turn their backs on the prospect of laboring in 100-degree heat, living in rat-infested dormitories and being cheated out of their earnings. They are instead staying in their home villages to take advantage of rising farm wages -- up 15 to 40 percent in the past year as the government streamlines taxes and as growing domestic spending power raises the price of vegetables and meat. Or they are finding jobs closer to home in the factories sprouting up in inland cities along China's expanding road and rail networks. "Manufacturing wages are going up, and they are going to keep going up," said Jonathan Anderson, a former International Monetary Fund official and now chief economist at UBS Investment Research in Hong Kong. Given the low starting point of wages, China will continue to capture low-end manufacturing jobs from around the world for the next decade, Anderson predicted. But by then, average wages are likely to exceed $100 a month, up from the current $50 to $60, and labor-intensive industries such as textiles and toys are likely to revert to countries now losing jobs to China, such as Thailand, Malaysia and Indonesia. Anderson, the UBS economist, argues that what is going on is not an overall lack of labor, but a shortage of the 18- to 24-year-old women preferred as factory workers. They are less likely to have family complications that pull them away from work and are more tolerant of poor conditions, managers say. "You have run out of this demographic," Anderson said.
But REIT shares aren't nearly as cheap as they were a few years ago. That has some investors worried, particularly because the Fed has started raising its target short-term interest rate and, when rates tick up, some risk-averse investors switch to fixed-income securities. The Fed is expected to bump up its target rate again next week. So far this year, real-estate funds are up an average of more than 12%. But they seem vulnerable to bad news. Fears of rising interest rates knocked the funds down more than 13% in April, their worst one-month loss is more than two decades, according to Lipper. "The double-digit losses in April showed investors they can suffer some serious losses in real-estate stocks," says Dan McNeela, a senior fund analyst at Morningstar. While still cheaper than the overall stock market, REITs are trading at a higher multiple of the cash flows they churn out than usual. REITs now trade at about 13 times their cash flows, compared with 11.5 times cash flows over the past 15 years, says James Corl, co-manager of the $1.7 billion Cohen & Steers Realty Shares fund. At the end of 1999, when their current run began, they traded at just about eight times their cash flows. These higher valuations worry some investors. In March, Litman/Gregory Asset Management, a fan of real-estate funds for many years, moved most clients out of the funds. The reason: REITs no longer looked cheap compared to the broad stock market, after years of looking like "an awesome opportunity," says Josh Weiss, director of research for the Orinda, Calif., firm. The firm's No-Load Fund Analyst newsletter had previously suggested investors put 5% of their assets in real-estate funds. Another concern stems from the popularity of the funds. Some worry that the gush of money into these funds could leave just as quickly if the sector falters, causing an even sharper decline in REIT shares. Thanks to new investments and capital appreciation, real-estate fund assets topped $33.2 billion at the end of July, up from less than $8.8 billion at the end of 1999, according to Financial Research Corp. In the first seven months of the year, assets of closed-end real-estate funds, which are measured separately, also surged to more than $11.7 billion from $7.7 billion, according to Lipper. Some experts aren't spooked. Cohen and Steers' Mr. Corl, for instance, believes that interest rates, which his analysis indicates haven't historically had much correlation to REIT-share moves, will rise only if the economy is growing. And a growing economy would lead to lower vacancy rates and higher rents for hotel rooms, apartments and commercial space. This healthy supply-demand dynamic should lead to rising profits, he argues, thus leaving REIT stocks trading at a lower multiple of those higher earnings. Don Cassidy, a senior analyst at Lipper, adds that demand for REITs and real-estate funds should be strong as retiring baby boomers look for income from their portfolios. Today the average real-estate fund has a 2.8% 12-month yield, according to Lipper, compared with about 1.8% for the S&P 500 and a little over 3% for the average intermediate-term bond fund. "REITs aren't quite stocks or bonds, and they don't really move in line with anything," he says. Thus their unique performance patterns, partly because of diversification among regions of the country, can cushion the blow of a tough time for stocks or bonds. Many real-estate funds also can own shares of home builders, land developers and other real-estate related companies beyond REITS. Since property prices typically rise with inflation, real-estate funds can help protect an investor's purchasing power, says John Brynjolfsson, a managing director of Pimco, and manager of the $336 million Pimco RealEstateRealReturn Strategy Fund. With interest rates rising, "it's hard to see double-digit gains in real-estate prices," he says. But over time, he says, property prices, and therefore real-estate securities, should rise at least in line with overall inflation. His fund buys derivative contracts whose performance is tied to the Wilshire REIT Index, and the fund attempts to pick up additional return by investing in inflation-indexed bonds. The once-sleepy sector is now more volatile. But Steve Buller, manager of the $3.5 billion Fidelity Real Estate Investment Portfolio, believes real-estate investments will continue to post competitive returns in coming years, if with a bit more volatility. Fidelity launched the new Fidelity International Real Estate Fund Wednesday, to bolster its REIT-fund offerings. But even some advocates of real-estate funds say investors should examine whether the sector's heady gains have resulted in their real-estate holdings' growing into a much bigger portion of their portfolio than originally intended. If so, they say, it might be a good time to consider taking some profits and investing them in harder-hit sectors.
None of the three retailers has immediate plans to expand in Montgomery. But Silverman's proposal comes as a relief to Wal-Mart officials who said they prefer it to one being pushed by County Executive Douglas Duncan. Wal-Mart executives say Duncan's measure more specifically targets their superstores -- 100,000-square-foot-plus stores that also sell groceries. Duncan's definition would, however, cover other stores with a large enough grocery component, such as Wegmans or SuperTarget. Mia T. Masten, Wal-Mart regional community affairs manager, called Silverman's bill "fairer" than Duncan's. "Our biggest concern is that the special exemption be based on the merits of individual projects," she said. "As long as the special exemption process is fair, it's something we'll work with." Duncan's proposal, introduced in February, would require a special permit for stores larger than 120,000 square feet that devote at least 10% of their floor space to food, beverage or prescription drug sales. Duncan's proposal would exempt membership clubs but not home improvement stores. The county executive argues that the public needs greater input over so-called combination retail stores because they generate more traffic than other big-box outlets. Duncan's proposal has the support of Giant Food, Safeway and the United Food and Commercial Workers union, which has contracts with those chains and has criticized Wal-Mart's use of nonunion labor. Giant spokesman Barry F. Scher said his company supports Silverman's bill, too. Silverman said he wanted to broaden the scope of Duncan's proposal because traffic data did not support the county executive's conclusion that discount stores with a grocery component generate more traffic than big stores that don't sell groceries.
"There isn't much demand for another retailer to come in and use that space," says Allison Cortner, the head of a local nonprofit economic development group who has been trying to find a tenant for the empty store. Wal-Mart's lease on the building runs through 2017. La Junta's situation is hardly unique. Throughout the country, hundreds of empty "big box" stores litter the suburban and rural landscape. Some were abandoned by chains that went out of business. Others were orphaned by corporate downsizings. And still others, like the La Junta one, were left behind when their corporate parents decided they weren't big enough. This build-and-abandon trend occurs everywhere in real estate as needs of tenants change, but it's particularly acute in retailing, where store formats can change as quickly as dress lengths. While big retailers can afford to write off or absorb the cost of closed stores and their ongoing leases, communities are often stuck with a different kind of bill. They complain that the empty buildings are eyesores that can boost crime and vandalism and bring down property values. And where darkened stores anchor strip malls, they can depress sales of remaining retailers. While the stores' owners typically continue to pay property taxes on the vacant properties -- that is, if they remain in business -- the buildings no longer generate jobs or lucrative sales-tax dollars for state and local governments. Finding new tenants for big properties isn't easy. Sometimes the very company that abandoned a store blocks a prospective new occupant. Wal-Mart in particular sometimes creates roadblocks when other discount merchandisers or supermarkets have expressed interest in its shuttered buildings, say some real-estate brokers and community officials. "Wal-Mart clearly says up front, 'We don't want anyone in the buildings with a competing use,' " says Suzanne Chen of Retail Realty Group of Tampa, Fla., which specializes in big-boxes. "Sometimes they would rather sit with a vacant building than budge on letting a competitor in it." In Fort Myers, Fla., for instance, Wal-Mart blocked a Save-A-Lot grocery store from subletting an abandoned store where it still held the lease, according to Ms. Chen. Wal-Mart runs a supercenter, which sells groceries along with the chain's other items, about a mile away. Wal-Mart spokesman Dan Fogleman says it actually did try to find a grocery store for the building. "However, there was already a supermarket on the other side of the shopping center, and the other chain chose not to locate there. ... This shows that we are willing to put competitors in our vacant buildings." An office-supply retailer now occupies the building. Still, another Wal-Mart spokesman, Bob McAdam, says the company won't go out of its way to help a competing retailer take over one of its empty stores. "There are times when it's in our interest to get the property moving faster, but we're certainly not going to give a competitor an advantage," he says. Retailers including Target, Kmart and Home Depot all have vacated big-box locations across the country. But Wal-Mart, because of its rapid expansion, probably has left behind more space than anyone else. It plans to add 50 million square feet of retail space this year around the world, a good chunk of that replacing existing stores it now considers dated. Wal-Mart, which has its own realty unit, says it will fill about 16 million square feet of this empty space this year, but that it still has about 152 vacant stores, or about 13 million square feet, across the nation. Some big boxes do end up being used by other retail chains. When discounters Ames Department Stores, Caldor and Bradlees went out of business, Wal-Mart and other retailers moved into many of their vacated digs. Home Depot and Sears now occupy some of the 600 or so Kmarts that were casualties of its bankruptcy filing in 2002. And Hobby Lobby Stores has moved into a number of vacant Wal-Marts. Oftentimes, the big boxes are divided up into several small stores: Wal-Mart says that about 60% of its empty boxes that have found new uses have been sectioned up for the new tenants. Still, many big boxes remain on the market for years. In Clinton, Miss., a Wal-Mart larger than two football fields stood vacant for four years before it recently was demolished. A Wal-Mart in Bardstown, Ky., remained empty for nearly 10 years before a flea market moved in. And La Junta, a town of 8,000 located three hours from Denver, just recently struck a deal to begin using a former Kmart that had been empty for 10 years as a coffee roasting plant, while a former Gibsons Discount Center, a regional discounter, still sits empty three years after its closing. Communities are getting more aggressive about trying to prevent big boxes from becoming empty in the first place. Some, including Conway, N.H., and Buckingham, Pa., have passed ordinances that limit the size of new stores -- thus making it less attractive to build a new store and abandon the old one. These towns often prohibit building owners from closing stores before the space has attracted a new tenant or plans are in place for the structure to be demolished. Some communities require retailers to tear down buildings that remain empty for a certain period of time. Others have helped find creative uses for empty big boxes, including a Mercedes-Benz dealership in Florida, a church in Oklahoma, a bingo hall in West Virginia, a Christian school in Arkansas and a pharmaceutical lab in Wyoming. Ron Kitchens, president of an economic development group in Corpus Christi, Texas, has helped both Wal-Mart and Kmart fill empty stores in his region. One Wal-Mart ended up as a plant for an office-furniture manufacturer, while a Kmart will soon become a phone company's call center. "If the buildings didn't work for the biggest retailer, then they're probably not going to work for other retailers," he says. "Communities have to be creative." Still, some communities figure they're better off with the added employment and taxes that come from a newer, bigger Wal-Mart even if it leaves them with an empty store. That was the case in La Junta, where the town extended its boundaries to allow the new superstore to be built. Constantly growing retailers like Wal-Mart, of course, could reduce the number of empty stores by simply expanding on the same site. The problem is that Wal-Mart says it needs 20 acres to build a supercenter, while most of its older discount stores sit on 10- to 12-acre sites. In East Greenbush, N.Y., Wal-Mart expanded one of its stores into a 203,000-square-foot supercenter, but only after smaller retailers in the strip mall were relocated to free up space. Wal-Mart, which owns about half its vacant buildings and leases the rest, insists it is working harder to fill the buildings by aggressively working with communities and brokers. The company also lists its vacant big boxes on its Web site, which reads like nationwide yellow pages: In Texas, Wal-Mart lists more than 40 empty stores for sale or lease, while Georgia has 23. By the end of the year, the Bentonville retailer plans to fill 70% of its empty boxes, says Tony Fuller, vice president of Wal-Mart Realty.
Q: Is the office market close to recovering from the recession that started in 2001? A: We believe that the national leasing market turned the corner in early fall 2003. We're beginning to see landlord concessions decrease on new leasing deals and, in some cases, real rent appreciation. The recovery was particularly evident in Southern California. The Bay Area is lagging, although downtown San Francisco is definitely improved from where it had been. But if that market ever gets to where it was in 2000 in terms of rental rates, it will be awhile. Q: Is there one Los Angeles County market in particular that's getting ready to pop? A: One of the ways to tell is to watch where the investment dollars are going. They are going downtown and the Westside. There is a lot going on downtown that leads people to believe that finally the dynamics to make this a good office market again are in place. I don't think it's misplaced optimism when you hear investors talk about the prospects for downtown Los Angeles. Q: Several big companies have left downtown in recent years, and the office market has been soft for more than a decade. Where is the growth going to come from? A: Downtown has nice buildings, good transportation into the area and it's fairly central. I think what has kept it knocked down were a couple of things. Go back 10 years and you have very high-quality office stock built in what were then suburban office markets on the Westside, in Glendale and other areas. The rents for that office stock were comparable to downtown, perhaps even a bit below. Then you saw downtown lose a lot of major banks, you saw a view in the marketplace that downtown lacked certain services and didn't have a residential base to support it. But those things are changing again. Today the price for office space downtown is highly competitive.
"Alas, most REITs are now severely overvalued. REIT dividend yields have dropped to an all-time low, below 5% for the typical equity REIT. (Data go back to 1972.) What's more, my technical studies lead me to believe that a major price top is coming soon in the REIT sector. "We need to harvest some of those juicy profits. Effective immediately, we're selling two REITs from the model portfolio, Cousins Properties and Equity Residential. We're also lowering our REIT allocation from 10% of the model portfolio to 5%." This still leaves Band holding Duke, Kimco, Vanguard REIT Index VGSIX And he adds: "What if you're holding your REITs primarily for income? Assuming you bought them some time ago at significantly lower prices, I see no need to sell. I must caution you, though, that I think the next bear market for REITs will take prices down 20% to 30%. Are you prepared to sit through that kind of volatility? Search your soul and make your own decision." Band is one of my "brave bulls" - he was among the three letters that called the low on the Dow in early 20003 and he remained bullish through this summer. And his record has been good. The Hulbert Financial Digest's analysis is that Band is systematically less risky than the market -- "will not hit home runs. However ... will do a good job of getting on base." Over the last five years through July, Band's portfolios appreciated on average at a 3.5% annualized rate, versus a 1.2% annualized loss for the market. Over the last year, Band's portfolios had matched the market -- a result of his brave bullishness -- but with less risk. Still, looking at his September letter, it does appear that Band is getting nervous. He wrote there about his long-standing nervousness re REITs. ("Yet, as long as interest rates stay low, REIT prices will stay in the clouds.") But, more alarmingly, while claiming that "I'm still rooting for a fourth-quarter rally that will push the year as a whole into the plus column," Band told readers to "focus your efforts an generating more income here and now...if you do, the capital gains will flow back to you in due course." Band worries that the stock market is not as robust as it normally would be in a presidential election year. He writes: "Over the years ... I've found that when the market doesn't do what it's "supposed" to do, an important reversal is often in the wind. Since 2002, the major trend for stocks has been up. Accordingly, the wise thing to do now is to beef up our defenses -- just in case 2005 brings tougher challenges ..." Pursuing this strategy REIT-wise, Band writes: "In place of the REITs we're selling, I advise you to move into convertible securities. My favorite convertible play right now is a closed-end fund, Ellsworth Convertible Fund (ASE: ECF). It's yielding a respectable 3.7%. Furthermore, ECF is trading at a rich 12% discount to net asset value, so there's plenty of room for the shares to appreciate as the discount narrows. Buy ECF at $7.70 or less."
FR also has shifted its focus back to redeveloping existing properties. President and Chief Executive Donald Wood said it is far less risky for the company to improve existing properties in densely populated markets, where the return on investment is generally greater, than it is to build new shopping centers in outlying suburbs. FR's shares are trading marginally higher than they were six months ago. Analyst David Fick said REIT shares tend to move slowly because they are considered to be long-term investments. REITs "have been outperforming all other sectors [in the stock market] for the past five years, but now they are at the point of being fully or properly valued," said Mr. Fick of Legg Mason Wood Walker Inc., a subsidiary Legg Mason. The Morgan Stanley REIT Index has climbed 5 percent in the past six months from 642.35 to 674.44. Mr. Fick, who advises investors to buy Federal Realty, does not own any Federal Realty shares, but Legg Mason has business with the company. Matthew Ostrower, an analyst with Morgan Stanley, said the stock was too expensive, rating the company as "underweight/cautious" for investors. "I'm a huge fan of the company's management and assets, but I do think its stock is a little too high," Mr. Ostrower said. Mr. Ostrower does not own any company shares, but Morgan Stanley has a banking relationship with Federal Realty. FR's FFO jumped 17% in the most recent quarter ended June 30 to $41.5 million (73 cents per diluted share) from $35.5 million (57 cents) a year earlier. Diluted earnings include the value of convertible warrants and stock options. While Mr. Fick expects slower increases ahead for Federal Realty's stock price and dividends, he said the company still has an edge in the retail real-estate market. High demand for the company's prime spots in the Boston, Philadelphia, New York, Washington and California gives the company more leverage when raising rents, Mr. Fick said. "At the end of the day, this company is getting back to basics."
Shares of the other REITs that specialize in major regional malls are up by 4% to 14%, with Mills Corp. leading the pack. Mills made its own mega-deal just three days before the sale of Rouse was announced, agreeing to pay $1 billion for a 50% stake in nine regional malls owned by General Motors. The two transactions support the theory that the value of major malls will keep going up because it's difficult to build more. Even if developers can find a rare desirable location where there isn't already a mall, the hurdles of getting such a project through the planning process remain very high. So the existing mega-malls are increasingly being linked into mega-mall chains. When GGP takes over Rouse, the majority of the nation's big enclosed malls will be controlled by seven big REITs -- eight if you throw in Westfield Group, the Australian company that owns the "Shoppingtowns" around the United States. Smaller malls, outlet center, strip shopping centers and "Big Box" centers are a different business, though they may be owned by regional mall companies. As the mall giants buy more giant malls -- and each other -- their property values are going up. "The Rouse transaction showed the market what the underlying value was in the real estate and it was higher" than previously recognized, said David Fick, the REIT analyst and mall expert at Legg Mason. Legg Mason is very active in investment banking for the REIT industry and has extensive ties to Mills and Rouse. Fick said malls that dominate their markets "are fortress assets and those assets are virtually irreplaceable." Old, smaller, out-of-date malls keep getting torn down, but only three new enclosed regional malls are opening in the whole country this year, he said. "No one can ever build a mall in the greater Baltimore-Washington area in my lifetime," Fick said. "None are planned or proposed." If the supply is fixed -- or nearly so -- and demand remains strong, then the value of mall real estate will keep going up, argued Fick. New stores going into mall locations this year have been paying rents 20% higher than the previous tenants, he said. There are suburbanologists and students of shopping who argue with Fick's thesis. Big box centers and "anti-malls" like Bethesda Row are taking business away from regional malls, they point out; so is Internet shopping. Other arguments: Department stores, which regional malls depend on, may be dinosaurs. The bigger malls get, the less convenient it becomes to shop there. Malls will have to find some other attractions to attract the necessary throngs of shoppers, which is why there is a roller coaster inside the Mall of America outside Minneapolis, the biggest U.S. mall. Mills has been a pioneer in the "shopping as experience" retail business ever since it built Potomac Mills in Prince William County, proclaiming that it was not a shopping mall, but a tourist attraction. That history helps explain the General Motors deal. Mills Corp. has long acknowledged that troubled malls need to be reinvented to bring back shoppers. Mills is becoming a partner with GM in nine properties. GM's original plan was to unload three underperforming properties and to find a partner to buy half interests in five other malls and run them. After hearing what Mills proposed doing with the properties, GM decided to keep a half-interest in all eight and to add another mall to the batch, said company spokesman David Douglass. "GM recognizes our record in doing exactly what we proposed to do with the properties, which would significantly boost their value," Douglass said. While known as a developer of huge properties like Arundel Mills, Potomac Mills and a dozen like them, Mills Corp. two weeks ago unveiled its first effort at reinventing a conventional mall. It took a rundown regional mall in Ohio, gutted everything but the department stores, rebuilt it and proclaimed it Cincinnati Mills. There were only 50 stores in the mall when Mills took over; it reopened with 190 and only 5% of the stores vacant. In Anne Arundel County, not far from Arundel Mills, is one of the nine properties Mills will share with GM: Marley Station, a conventional enclosed mall. Douglass said Mills will not turn Marley Station into a "mills" type property -- not with Arundel Mills nearby. "There are significant differences in the way they are tenanted and in how we'll redo Marley Station," he said, declining to provide details. Nor will Mills say what it plans to do with Lakeforest Mall in upper Montgomery County, another of the properties included in the GM transaction. That deal is scheduled to close in mid-October. Mills will take over management from Taubman by the end of the year. Anchored by Sears, Roebuck; J.C. Penney; Hecht's and Lord & Taylor (the last two are sister chains owned by May Department Stores of St. Louis) Lakeforest probably is not ripe for the "mills" treatment with factory stores and promotional retailers. But it could be given the same kind of treatment planned for Westfield Shoppingtown Montgomery, which is scheduled to get a multi-screen movie complex, a batch of upscale restaurants and some new retail stores with entrances on the outside of the mall. Even with its ambitious expansion plans, Mills could be one of the companies that is acquired as the mega-mall consolidation continues, Legg Mason's Fick said. He considers MaceRich and Taubman as the most likely to be bought. Taubman fought off a hostile takeover bid by Simon Property Group last year and says it is not for sale, as does MaceRich. Mills declined to comment on whether it might be an acquisition target. Fick points out that the Rouse transaction provides a rough guide to the gap in how Wall Street and the mall industry value the major mall REITs. Rouse is being sold for $67.50 a share, 33% more than the $50.61 a share that Rouse stock was selling for before the GGP bid. Even with the recent increases in their stock prices, other mall REITs are bargains based on what GGP is paying for Rouse.
Guillermo Prieto Trevino, president of the Bolsa, said: "We think this is an important alternative. It's important because it will give financing to a sector where there are many fixed assets that could be made more liquid. Eventually we hope it could be open to the private pension funds and the banks." Prieto added: "Real estate investors are very interested in being able to sell properties through the market. We expect to see the first Fibra before the end of the year. And we think the potential is great." He predicted that foreign capital would probably be involved in the first issues. The stock exchange's move follows a recent revival in initial public offering activity in Mexico, spurred mostly by the strength of the housing industry. Mexico has a severe shortage of homes for its fast-growing population, reassuring developers that there will be consistent demand, as well as support from the government. Most impressive was the June IPO by Desarolladora Homex, a housing developer on the northern border, which had backing from Equity International Properties, a vehicle for Chicago-based investor Sam Zell, and ZN Mexico Funds, a New York private equity group. The listing, which took place simultaneously in Mexico City and New York, raised $155 million, and the shares have performed well since their flotation. In May, Urbi Desarollos Urbanos, another builder, made a similar simultaneous offering in New York and Mexico City, raising $182 million. There have also been a number of private equity deals in the commercial real estate sector. In June, LaSalle Investment Management, part of Jones Lang LaSalle, paid $300 million for a portfolio of 52 industrial properties and one office block to Grupo Acción, a Mexican developer, in the largest ever Latin American real estate transaction. Luis Gutierrez, Acción's chief executive, said: "This kind of transaction makes the real estate sector more attractive and is a step toward a liquid market." He said the deal would allow Acción to redirect resources to middle-income housing, an area that had failed to meet demand after the virtual collapse of the mortgage market a decade ago. Acción is also taking advantage of the low international interest-rate environment, which makes it easier to persuade institutional investors to look for higher yields from Mexican real estate. More recently, the California Public Employees' Retirement System, which provided backing for the LaSalle deal, announced that it would invest $150 million in a joint venture set up by Prudential Real Estate Investors of the U.S. and Geo, Mexico's biggest housing developer.
Growth-hungry companies are taking advantage of low borrowing costs in the bond market and record high stock prices to acquire companies or assets. High equity prices make it attractive for companies to use their own shares to fund deals. "There are windows of opportunity for consolidation in the sector and one clearly is right now," said Lesia Bates Moss, a Moody's Investors Service analyst. "We expect merger and acquisition activity to remain a growth vehicle for the near term." For bond investors, REITs are considered a safe place to park money at a time when many assets are posting low or negative returns, analysts said. "They're very stable buy-and-hold investments," said Rob Haines, an analyst at fixed-income research service CreditSights. REITs have tangible assets, defaults are rare and their bonds typically have strict covenants, or borrowing agreements, that protect bondholder interests, he said. REITs suffered a sell-off in April amid fears of rising interest rates, which can raise borrowing costs and make REITs' dividends look relatively less attractive. Rate fears subsided after a soft patch in the economy over the summer. Bonds in the real estate sector have posted total returns of 3.45% this year, compared with about 3.25% for corporate bonds overall, Banc of America Securities said. Shares of real estate investment trusts, as measured by the Morgan Stanley REIT index, hit an all-time high of 668.63 on Tuesday and ended the day at 668.61, up 14% this year. REITs and other real estate companies have completed more than $48 billion in mergers and acquisitions this year, up from about $22 billion in the same period last year, according to Thomson Financial. Totals include net debt of the acquisition. Refinancing of short-term debt has been another driver of bond issuance, analysts said. Bondholders became wary of acquisitions earlier this month when General Growth Properties said it was purchasing Rouse for $7.2 billion plus assumed debt in a largely debt-funded deal. Because of the added debt, ratings agencies warned both companies' ratings could be cut. "Clearly, mergers and acquisitions have risk, but this was the first notable negative in a couple of years," said Christopher Brown, a Banc of America Securities analyst. Credit quality is relatively healthy in the sector, despite a cyclical downturn over the past few years, according to Brown. There are some potential drawbacks, though, such as supply pressure from new bond sales and muted job growth, a factor in real estate demand, he said in a recent report. Quick Facts, Stats & Opinions In a press release Tuesday, EOP said it now expects earnings per share for the year of 28 cents and 38 cents, down from its previous forecast of 79 cents to 89 cents. Wall Street is expecting earnings of 87 cents a share, according to Thomson First Call. The company also cut its estimate for full-year funds from operations, a measure of REIT earnings, to $2.05 to $2.15 a share, from its August projection of $2.55 to $2.65 a share. First Call's mean estimate is $2.60 a share. Equity Office began the year expecting earnings per share of 85 cents to $1 and funds from operations of $2.55 to $2.70 a share. In 2003, the company posted earnings of $1.50 a share and funds from operations of $2.80 a share. (WSJ 9-14) The average REIT had a 5.34% dividend yield the 12 months ended August, vs. 1.8% for the S&P 500. REITs typically pay about 1.2 percentage points more than the yield on the 10-year Treasury note, currently 4.21%. So REITs are right in their normal range. (Johm Waggoner, USA Today 9-5) The total free market capitalisation of the REITs is $262 billion, of which 72 percent is for U.S. firms, 13 percent for Australia, 4 percent each for France and Japan and 3 percent for the Netherlands. (Reuters 8-3) Update: Third Experiment in Stock Picking 9-30-04 A less than sector balanced portfolio is compared with the average of two REIT index ETF's: ICF [Cohen & Steers Realty Majors - the top 30 REITs by market cap] and RWR [the REIT Wilshire Index]. The first experiment went from Nov 02 to Oct 03 and the second experiment went from May 03 to May 04. This experiment continues a shift towards being over weighted in retail and having two key holdings - MLS and VNO. Earnings Guidance: CARS expects 2004 FFO of $2.52 to $2.56 a share, up from its prior guidance range of $2.47 to $2.52 a share. Thomson First Call currently targets FFO of $2.51 a share for the year. On 1-21 CARS increased its quarterly dividend to $0.4165 from $0.4140. The new annual rate is $1.666 per share. CARS also reaffirmed its 2004 annual dividend guidance of $1.70 per share. The company expects 10% to 15% of that dividend to be a return of capital. CARS on 4-13 announced that it declared a quarterly dividend of $0.4200 per common share of beneficial interest for Q1 ending March 31, 2004. The dividend is payable on May 20, 2004 to shareholders of record as of May 10, 2004. AMB gave 04 FFO guidance of $2.30 - $2.40/share in their Q4 conference call on 1-14-04. The current consensus estimate is $2.34. AMB declared a regular cash dividend for Q1-04, of $0.425 per common share. The dividend reflects an annual rate of $1.70 per share, an increase of 2.4% over the 2003 dividend of $1.66 per common share. The dividend will be payable on 4-15-04, to common stockholders of record at the close of business on 4-5-04. UDR estimates that recurring cap-exp for 04 will be $470 per apartment home, or $0.25 per share [and UDR increased the cap-ex estimate to $510 in the Q2 call - as they continued to get 15% plus ROI on the investment in upgrades]. UDR's guidance for 2004 FFO is a range from $1.48 to $1.60 per share; and guidance for Q1-04 FFO is a range from $.37 to $.38 per share. UDR announced a regular quarterly dividend on its common stock for Q1-04 in the amount of $.2925 per share, payable on April 30, 2004 to shareholders of 4-16-04. This represents a 2.6% increase over the same period last year. OFC gave 04 FFO guidance of $1.66 - $1.71/share in their Q4 conference call on 2-11-04. The current consensus estimate is $1.69. On 9-14 OFC declared a quarterly dividend of $0.255 per Common Share of beneficial interest for Q3-04, an 8.5% increase from the previous $0.235 per share quarterly dividend. MLS increased the common stock cash dividend for Q1-04 by 5.3% to $0.595 per common share. The dividend will be payable 5-3-04 to shareholders of record on 4-23-04. MLS 2004 FFO Projection: $3.90 - $4.00. The current consensus estimate is $3.96. ARE on 3-17 declared a quarterly cash dividend of 60 cents per common share for Q1-04. The dividend is payable on April 15, 2004 to shareholders of record on April 2, 2004. The quarterly common share dividend represents a 3% increase to 60 cents per share from 58 cents per share paid for Q4-03. With one of the industry's lowest payout ratios, the Company announced this dividend increase after an aggregate dividend increase for 2003 of 16%. ARE on 6-21 declared a quarterly cash dividend of 62 cents per common share for Q2-04. The common share dividend represents a 3.3% increase in Alexandria's quarterly dividend. The dividend increase follows a 3.5% increase for the first quarter of 2004 for an aggregate 6.8% increase so far during 2004. The Company had an aggregate dividend increase of 16% during 2003. More REIT Links
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