Tài liệu INVESTING IN REITs PART 3 ppt

profit-Many individual real estate investors harbored a distrust for public markets REITs included, which they saw as roulette tables where investors put themselves at the mercy of facel

And Mythology

REITs: MYSTERIES AND MYTHS

acceptance, there have been lingering mysteries and myths that REITs haven’t been able to shake off This chapter addresses these misconceptions and lays the fading myths to rest once and for all

C H A N G I N G A T T I T U D E S

T O W A R D R E I T S

For many years, REITs were regarded as odd and uninteresting investments Even their unusual name—REIT—implied that the standard criteria applicable to most investments didn’t apply to them Bruce Andrews, the former CEO of Nationwide Health

Properties, noted that the term trust, as in real estate investment

trust, implies that REITs are oddities, that they are not like normal corporations whose shares are traded on the stock exchanges One

of the main reasons that REIT stocks were suspect for so long is that many people who traditionally invested in real estate didn’t really understand—or trust—the stock market, while most people who invested in the stock market were uncomfortable with, or had little understanding of, real estate REITs just didn’t fit into either category and therefore fell between the cracks

All this has finally changed In October 2001, Standard & Poor’s admitted the largest REIT, Equity Office Properties, with an equity market cap at that time of $12 billion, into the S&P 500 index Equity Residential Properties Trust, the largest apartment REIT, was admitted soon thereafter, and at the end of 2004, there were seven REITs in the S&P 500 At the end of 2000, when the equity market cap of all REITs was $139 billion, many REIT observers believed that, within ten years, REITs’ total market cap would reach $500 billion Well, at the end of 2004, that figure had already exceeded $300 billion

Of course, the growth in the REIT industry will wax and wane from time to time And there are lots of good reasons why many investors might want to own real estate directly, not via an invest-ment in a REIT Nevertheless, the advantages of ownership through

a REIT are very substantial, and the size of the REIT industry will continue to grow with increased investment by both individuals and institutions who appreciate REITs’ liquidity, substantial informa-

of capital spending by businesses, not the overbuilding that’s been the main culprit in prior real estate cycles Perhaps operating in a fishbowl, as public REITs do, imposes substantial development dis-cipline, which even carries over to the private markets.

THE BIAS OF TRADITIONAL REAL ESTATE INVESTORS

Traditionally, most real estate investors have chosen to put their money directly into property—apartment complexes, shopping centers, malls, office buildings, or industrial properties—and not in real estate securities like REITs In other words, bricks and mortar, not stock certificates Direct ownership historically has provided the opportunity to use substantial leverage, since lenders have tradi-tionally been willing to lend 60–80 percent of the purchase price of

a building Leverage is a wonderful thing—when prices and rents are going up

Since the Great Depression, real estate values pursued a able upward bias, notwithstanding a few potholes along the way Appreciation of 10 percent on a building bought with 25 percent cash down would generate 40 percent in capital gains In addition, owning a building directly provided the investor with a tax shelter, via depreciation expenses, for other operating income As a result, real estate continued to appreciate and provide easy profits, and most real estate investors tended to focus on what they knew—direct ownership

profit-Many individual real estate investors harbored a distrust for public markets (REITs included), which they saw as roulette tables where investors put themselves at the mercy of faceless managers—

or worse, speculators and day traders whose income depended

on volatility These investors saw REITs as highly speculative and wouldn’t touch them

to buy portfolios of properties Who managed these properties, supervised their performance, and answered for their results? The same sort of real estate investors who, of course, didn’t trust the stock market—or, if they had no such qualms about equities, didn’t believe that the performance of REIT shares would match that of direct real estate investments.

Furthermore, since REITs are traded as common stocks, the result was—catch-22—that a decision to invest in REITs could

be made only by the “equities investment officer” rather than the

“real estate investment officer” of the institution or pension fund

The institutions’ common stock investment funds were placed and monitored elsewhere Furthermore, various investment guidelines often precluded the equities investment officers from investing in REITs—even if they knew about them and wanted to pursue this sector of the market And why should they bother? After all, REITs have always been a very small sector of the equities market and were not included in the S&P 500 index until 2001

A further discouragement has been volatility Real estate tors have complained that REITs, even though traditionally less volatile than the broader stock market, nevertheless do fluctuate in price However, to be fair, any asset fluctuates in price With illiquid assets that were held, not traded (and by relying upon occasional appraisals), the private-fund managers could maintain the illusion that the values of their assets were “steady as a rock,” despite the continuous ebb and flow of the real estate capital markets Every asset fluctuates in value, but owners are sometimes unaware of these changing valuations until they try to sell the asset

inves-Finally, institutions buy and sell stocks in large blocks, and it’s been only recently that REIT shares have had sufficient liquidity

to attract institutional investors In fact, one of the most oft-quoted reasons why pension funds have been reluctant to invest in REITs is their lack of liquidity The REIT market was so thinly traded prior

THE BIAS OF COMMON STOCK INVESTORS

What discouraged common stock investors from buying REITs? The flip side of the coin is that REITs’ only business is real estate and stock investors didn’t invest in real estate; they focused primarily

on product or service companies Real estate was perceived as a ferent asset class from common stock; this problem was particularly acute in the institutional world

dif-REITs have also been perceived as real estate mutual funds, and not as active businesses—a perception precluding REITs from being admitted to the S&P 500 until 2001 An IRS ruling at that time confirmed that REITs are active businesses, but old percep-tions die hard

In addition, the public perception—wrong as it was—was that REITs were high-risk but low-return investments There were many investors who had bought construction-lending REITs and real estate limited partnerships in the 1970s and 1980s and gotten badly burned These investors did not take the trouble to distinguish between these ill-fated investments and well-managed equity REITs

Also, for years investors had been told that companies that paid out a high percentage of their income in dividends did not retain much of their earnings and therefore could not grow rapidly Since,

to most common stock investors, growth is the hallmark of ful investing, they didn’t want to invest in a company that couldn’t grow Finally, some of the blame for lack of individual investors’ interest in REITs can be laid at the feet of stockbrokers

REITs for a long time were perceived as stocks by real estate investors, and as real estate by stock investors.

Until about fifteen years ago, most major brokerage firms did not even employ a REIT analyst And, since individual investors generally bought individual stocks only when their brokers recom-mended them, the REIT story fell on deaf ears Mutual funds have

REITs, of course, given their favorable investment tics, were bound to be noticed sooner or later They are gradually but inexorably becoming well known to real estate and common stock investors alike, and REITs’ long period of being neglected is now ancient history Interest in REIT stocks will ebb and flow with changes in investor fads and preferences, but they are now firmly recognized as strong and stable investments that help to diversify a broad-based investment portfolio.

characteris-T H E M Y characteris-T H S A B O U characteris-T R E I characteris-T S

In addition to—and sometimes because of—the other obstacles REITs have had to overcome, some myths exist, myths that in the past scared off all but the bravest investors Although these myths were based on misunderstandings of the investment characteristics

of REITs, they discouraged many would-be investors Let’s confront them, one by one

M Y T H 1

REITS ARE PACKAGES OF REAL PROPERTIES

This myth, which probably sprang from investors’ experience with the ill-fated real estate partnerships of the late 1980s, may be the single most significant reason for REITs’ failure in the past to attract a substantial investor following Although at one time REITs may have been only collections of properties, or “real estate mutual funds,” they are much more than that today

REITs are more than just portfolios of real properties.

Organizations that merely own and passively manage a basket

of properties—whether they be limited partnerships, trusts, or

is often unresponsive to small problems that can, if left

unattend-ed, develop into big problems Also, management does not ally have its compensation linked to the success of the properties and therefore has no particular incentive to be innovative despite today’s competitive environment Often, there is no long-term vision or strategy for creating value for the investors Finally, inef-ficient management rarely has access to attractively priced capi-tal, making it difficult for the entity to take advantage of “buyers’ markets” or attractive purchase or development opportunities An investment in such a passive company, although perhaps provid-ing an attractive dividend yield, offers little opportunity for growth

usu-or expansion beyond the value of the usu-original pusu-ortfolio

Conversely, a large number of today’s REITs are vibrant, dynamic real estate organizations first, and “investment trusts” second They are far more than collections of properties Their management is savvy and highly motivated by their own ownership stake and other equity incentives They plan intelligently for expansion either in areas they know well or in areas where they believe they can become dominant players, and they frequently have access to the capital nec-essary for such expansion They attempt to strengthen their rela-tionship with their tenants by offering innovative and cost-efficient services To categorize highly successful real estate companies, such

as AMB Property, Alexandria, Archstone-Smith, Avalon Bay, Boston Properties, the “Equities,” General Growth, Kimco, Home, Macerich, Reckson, SL Green, Simon, Taubman, Vornado, or Weingarten, to cite just a few examples, as just collections of properties, or “mutual funds of real estate,” is to underestimate them seriously Yet this myth still persists, even among some institutional investors

M Y T H 2

REAL ESTATE IS A HIGH-RISK INVESTMENT

It’s amazing how many people believe that real estate (other than one’s own home, of course) is a high-risk investment through which investors can be wiped out by tenant defaults or declines in prop-erty values And, they surmise that if real estate investing is risky, then REIT investing also must be risky Let’s analyze risk here

◆ Leverage.Leverage in real estate is no different from leverage

in any other investment: The more of it you use, the greater your potential gain or loss Any asset carried on high margin, whether

an office building, a blue-chip stock, or even a T-note, will involve substantial risk, since a small decline in the asset’s value will cause

a much larger decline in one’s investment in it However, because real estate historically has been bought and financed with a lot of debt, many investors have confused the risk of debt leverage with that of owning real estate

Although real estate investments have often been highly aged, it is the high leverage rather than the real estate that is the great- est risk.

lever-In fact, one could argue that if lenders will lend a higher age of a real estate asset’s value than the Federal Reserve will allow banks and brokers to lend on a stock investment, then real estate must be less risky than stock investments

percent-◆ Diversification. Again, the same rule that applies to other ments applies to REITs: Diversification lowers risk People who would never dream of having a one-stock portfolio go out and buy, individually or with partners, a single apartment building or shopping center Things happen—an earthquake, neighborhood deterioration, excessive building, a recession—and all of a sudden the building is sucking up money like a sponge Never mind that

invest-O N E C invest-O M M invest-O N M I S C invest-O N C E P T I invest-O N

WHEN ONE REIT encounters difficulty, investors sometimes rashly conclude that REITs as an asset class are very risky Yet no one would condemn the entire stock market just because the price of one stock had collapsed.

◆ Management quality. Then, of course, there is the issue of agement Good management is crucial—but that is not only true

man-in real estate If you look around at major U.S non-REIT tions, you can see, for instance, the value of a Jack Welch to General Electric, or how Bill Gates’s vision brought Microsoft to where it

corpora-is today Incompetent management can ruin a major corporation

or a neighborhood candy store Real estate, like all other types of investments, cannot simply be bought and neglected; it requires active, capable management And good management teams are able to select real estate for acquisition and ownership that is likely

to appreciate, not depreciate, over time Despite this, many wise intelligent investors have bought apartment buildings, small offices, or local shopping centers, often in poor locations, and tried either to manage them themselves in their spare time or to give control to local managers who have little incentive to run the prop-erty efficiently What happens? The apartment building or strip center does poorly, and the investor loses money and jumps to the wrong conclusion—that real estate is a high-risk investment

Part of the reason for the real-estate-as-inflation-hedge myth may come from the fact that real estate happened to do well during the inflationary 1970s, while stock ownership during the same period was not as productive This, quite likely, was a simple coincidence

According to Stocks, Bonds, Bills, and Inflation 1995 Yearbook,

pub-lished by Ibbotson Associates, equities have been very good inflation hedges over many decades So has real estate But the reality is that neither the real estate market nor the equity market is substantially better or worse than the other in this regard

Yes, there are times when inflation appears to help the real estate

investor by boosting the replacement cost of real estate, but such inflation can also increase operating expenses such as maintenance, other management costs, insurance, and taxes and thus restrain a property’s net operating income growth, which could negatively affect its market value

The value of a commercial building is determined essentially

by three principal factors: the net operating income the owner derives,

or is expected to derive, from the property; the multiple of that income that the buyer is willing to pay for it (which, in turn, is based upon a myriad of factors); and its replacement cost And these factors fluctuate

in response to various market forces; the expected rate of inflation is only one of those forces.

High inflation can positively or negatively affect rental rates and net operating income A positive influence resulting from inflation,

at least in the retail sector, can come from the higher tenant sales that normally result from increased inflation and higher prices on goods sold to consumers Although these higher sales can translate into higher rents for property owners, this benefit will be short-lived

if the retailers can’t maintain their profit margins If stores are not returning profits, it will be difficult for the owners to raise rents Similarly, higher inflation can help apartment owners by increas-ing tenants’ wages and thus their ability to afford higher rents, but only if wages are rising at least as rapidly as the price of goods and services

When supply and demand are in balance, inflation may enable owners to raise rents because, as the cost of land and new construc-tion rises, rents in new buildings will have to be high enough to cover these higher costs If the demand is sufficient to absorb the new units that are coming into the market, owners of preexisting properties will often be able to take advantage of the new proper-

ties’ “price umbrella” and charge higher rents Real estate is not

an effective hedge against inflation, however, when there is a large oversupply of competing properties

Higher inflation rates can also have a negative effect on the value

of real estate, certainly over the short term The Federal Reserve acts

as a watchdog for inflation, and, when there is a perceived ary threat, the Fed will raise short-term interest rates Higher inter-est rates are meant to slow the economy, but interest rates that rise too high can strangle it, causing a recession Once a recessionary economy exists, a property owner will have difficulty raising rents and maintaining occupancy levels, and therefore will not be able to generate higher net operating income

inflation-Now for the second part of the property-value equation: the tiples of net operating income that buyers may be willing to pay The price of a property is often determined by applying a multiple

mul-to its existing or forward-looking annual operating income (or by using its reciprocal, the cap rate), but the multiples (or the cap rates) don’t always stay the same There is an argument that buyers will pay more for, or accept a lower cap rate on, real property dur-ing inflationary periods Since investors view real estate as a hard asset, like oil and other commodities, they may be willing to pay a higher multiple for every dollar of operating income if they per-ceive that accelerating inflation will lead to higher rents

The counterargument is that cap rates may indeed be influenced

by inflation, but in reverse Higher inflation will often drive up interest rates, which in turn will increase the “hurdle rate of return” demanded by investors in a property, and have the effect of increas-

ing the required cap rate and thus decreasing the price at which the

property can be sold Conversely, property values may rise even with

no inflation whatever, as interest rates decline in a zero-inflation environment Property values certainly increased in 2003–04 when interest rates and inflation were at very low levels Consider the fol-lowing example:

If the demand for apartment units in San Francisco exceeds the available supply of such units, rents will increase and the apartment building owner’s net operating income will increase Thus, one might think that the value of the apartment community would also rise However, if this demand for apartment space has been fueled

operating income might also rise, perhaps even causing a loss in

value of the asset

On the other hand, if the supply of apartment units in San Francisco exceeds the demand by renters, as was the case from 2001

to 2004, rents and net operating income may fall—but the value of the apartment community may nevertheless rise, due to a lower cap rate applied to that net operating income And all of this has little

to do with inflation

It is likely that replacement cost for a real estate asset will rise during inflationary periods, but this alone won’t increase the prop-erty’s market value if the profitability of the asset falls short of buy-ers’ requirements; it means only that new competing properties are unlikely to be built until market values exceed replacement cost

Market factors like supply and demand, along with interest rates, are almost always more important than inflation in determining property value REIT investors should focus more on market conditions and management ability than on inflation.

M Y T H 4

DIFFICULT REAL ESTATE MARKETS MEAN

BAD NEWS FOR REIT INVESTORS

Real estate has at some times been a terrific investment and, at other times, a terrible investment Right now, all available informa-tion suggests that real estate, as an asset class, will fare reasonably well through the rest of the decade

A favorite observation among stock traders, after a long bear market that has finally turned around and moved up strongly, is

“The easy money has already been made.” Despite weak real estate markets from 2001 through 2004, property values held up well due

to real estate’s popularity as an asset class And now, although a recovery is under way, it is unlikely that in most sectors of the real estate industry, property owners will be able to generate growth in rental rates and operating income much in excess of the rate of inflation, which is 2–3 percent annually Some pockets of opportu-nity will always surface from time to time, but today most real estate

to raise prices, and employees are finding it equally difficult to get significantly higher wages The bottom line for real estate investors

is that, as long as these competitive trends continue, and if excessive supplies of new developments do not trash real estate prices and create opportunities for bargain hunters, it will be difficult for them

to generate returns above long-term norms

Nevertheless, if real estate investors can obtain initial investment returns of 5–7 percent from property acquisitions and enjoy operat-ing income growth in line with inflation, REITs should remain very solid investments—competitive with other asset classes Furthermore, many REITS may, at times, be able to take advantage of opportunities presented by challenging real estate environments, just as they take advantage of opportunities in favorable environments

Excellent managements view difficult conditions and tenant bankruptcies as opportunities United Dominion went on a buy-ing spree during the apartment depression of the late 1980s and early 1990s, while Apartment Investment and Management and Equity Residential bought huge amounts of undermanaged apart-ment communities several years later and spread their operating costs over a much larger number of units Nationwide Health and Health Care Property bought defaulted nursing-home loans from the Resolution Trust Corporation (RTC) at 16–18 percent yields Kimco Realty bought the properties, and even the leases, of trou-bled retailers and found new tenants willing to pay higher rents A

number of years ago, Weingarten Realty actually increased its

occu-pancy rates during the Texas oil bust, as many tenants vacated empty locations and migrated to Weingarten’s attractive shopping centers More recently, in 1999 Cousins Properties bought The Inforum, a 50 percent-leased office building in downtown Atlanta,

for approximately $70 million It invested an additional $15 million

in improvements and signed a new lease for about 30 percent of the building Within approximately two years, it was earning a return

of about 12.5 percent on the total investment These are but a few examples of how lemons can be turned into lemonade by imagina-tive and capable real estate organizations with access to capital.Conversely, it can also happen that a great real estate market is

“hit the wall” in the mid-1980s, when real estate prices were rocketing Not only were properties simply not available at prices that would provide acceptable returns, but owners were also facing competition from new construction Before anyone realized what was happening, the cycle moved into the overbuilt phase and cash flow growth slowed markedly

sky-As we’ll see in more detail later, REITs can grow their profits both internally, through rising operating income, and externally, through property acquisitions and new developments Poor real estate markets may create external growth opportunities if distressed sellers are numerous, but it doesn’t always happen this way; there were few distressed sellers during the last real estate recession, and there were numerous buyers One never knows how any particular real estate or capital market cycle will play out, but the point here

is that strong REIT organizations with access to ample capital may

be able to take advantage of opportunities often created by tough real estate markets While cash flow growth would slow temporarily

in response to such difficult rental markets, these REITs’ ability, at certain times, to buy sound properties at cheap prices enables them

to create substantial value for their shareholders

The extent to which a well-managed REIT can avail itself of the opportunities presented in a down market depends upon the amount and cost of available capital, the depth of the market weakness, and the extent of competition from other buyers.

Some of the best investment opportunities arise when a company

or even an entire industry is overlooked or misunderstood by the great mass of investors Legendary investors Warren Buffett and Peter Lynch made their reputations not by buying the growth stocks

The same principle applies to REITs REIT stocks are “all-weather” investments for diversified portfolios, but are particularly attractive when nobody wants to own them Investors’ past fears and hesitations had, for a long time, left these lucrative investments largely undiscov-ered and, therefore, undervalued REITs have become more popular

in recent years, but myths and misconceptions die hard, and one never knows when investors will again trash them for all the wrong reasons Those who understand them are unlikely to follow scared sellers to the exits

M Y T H 5

REIT STOCKS ARE FOR TRADING

How often have you read in a financial magazine or newspaper,

“Is now the time to get into (or out of) REITs?” It seems that we are always being hit with that inane question Why is it asked so often?

I believe the reason is the existence of yet another myth that is often encountered with respect to REITs: That they are meant for inves-tors to get into and out of from time to time, perhaps “cyclical” stocks that must be market-timed if one is to make any money in them

This mind-set is, I believe, one of the most dangerous myths of all It makes several assumptions, all of which are erroneous These include: (a) REIT stocks must be bought and sold at the right time

if one is to do well with them; (b) real estate and REIT stock prices, market conditions, interest rates, and capital markets can be suc-cessfully anticipated and timed by astute investors; and (c) that the reason for buying and selling REIT stocks is to score big wins and to avoid equally large losses Wrong, wrong, wrong!

First, REIT stocks needn’t be bought and sold frequently; indeed, they are the ultimate “buy and hold” investment Their total return performance, averaged over many years, has been outstanding, and certainly competitive with the broader equities markets More than

50 percent of their returns to investors come from the dividend yields, so investors get paid to wait for the additional reward of stock

Second, the most wealth has been created by investors who buy

and hold the stocks of excellent companies, for example, Warren

Buffett There is little evidence that traders or market-timers have been able to consistently make money in the stock market And this

is certainly true in REIT world To successfully time the purchase and sale of REIT stocks, one must be able to forecast accurately the direction of interest rates (both long-term and short-term), real estate markets throughout the U.S., capital flows of both institu-tions and individuals, rates of inflation and unemployment, and all the other factors that determine real estate and stock prices This cannot be done consistently and, for 99.9 percent of all investors, isn’t worth the effort

Finally, most intelligent investors do not invest in REIT stocks for quick and sizable capital gains, as one might seek to do in steel, air-line, or technology stocks REIT stocks are best owned for consistent dividend payments, modest price appreciation, over time, corre-sponding to increases in cash flows and asset values, and low correla-tions with other asset classes The investors who do best with REIT stocks are those who have the most patience, are willing to ride out the occasional bear market, and are not expecting to hit home runs The claim that REIT stocks are best traded but not owned is truly

a myth, and a dangerous one Intelligent financial planners and advisers are telling their clients to decide on an appropriate alloca-tion to REIT stocks within their diversified investment portfolios and to stick with them, perhaps rebalancing from time to time to maintain that allocation We’ll spend a bit more time on this topic later in the book

diversifica-◆ Although real estate investments have often been highly leveraged, it is the high leverage, rather than real estate itself, that is the major risk.

◆ Real estate as an investment can be hurt as much as helped by inflation.

◆ Market factors like supply and demand, interest rates, the existing and future strength of the economy, and investors’ preferences and available investment alternatives are almost always more important than inflation

in determining property value REIT investors should focus more on market conditions and management ability than on inflation.

◆ Even if the near-term outlook for real estate is not good, REITs with access

to capital will be able, at times, to grow their profits by taking advantage

of favorable acquisition opportunities

◆ REIT stocks are not “trading vehicles,” and should be owned for dividend yields and modest capital appreciation over long periods of time.

A History

Of REITs

AND REIT

PERFORMANCE

As an investor, you want to be equipped with as many

ana-lytical tools as possible Knowing how a particular type of investment has behaved in the past is a crucial yardstick in

determining not only whether or not you want to buy it, but also how much of it you want to buy relative to other assets in your portfolio How have REIT stocks behaved during the more than forty years since they were conceived? Like a child, like a teenager, and like

an adult, depending upon which stage of their development you examine We’ll take a look at those developments—specifically, how REITs performed in their infancy, how they created havoc

in their wild adolescent years, and how they’ve matured into solid citizens of the investment world We will also consider how REITs have behaved in response to different real estate and economic environments

T H E 1 9 6 0 s

I N F A N C Y

The REIT structure was officially sanctioned by Congress and signed into law in 1960 It allowed individual real estate investors to “pool their investments” in order to enjoy the same benefits as direct real estate owners Once the structure was created, it was only a few years until the first REITs were established, but these REITs were not

“pretty babies” by today’s standards

According to a report by Goldman Sachs, The REIT Investment Summary (1996), only ten REITs of any real size existed during the 1960s Most of them were managed by outside advisers, and all property management functions were handled by outside compa-nies Many of these management companies were affiliated with the REITs’ advisers, which created significant conflicts of interest The REITs’ portfolios were miniscule, ranging from $11 million for Washington REIT (one of the few survivors) to the $44 mil-lion REIT of America Industry-wide real estate investments were very small at the beginning, amounting to just over $200 million (For comparison, by late 2004, REITs owned real estate assets of

approximately $535 billion.) These early REITs were small in size,

and their insider stock ownership was negligible—typically less than

1 percent

Despite these weaknesses, the Goldman Sachs report shows that these early-era REITs turned in a respectable performance, aided

by generally healthy real estate markets in the 1960s Cash flow (the early version of today’s funds from operations, or FFO) grew an average of 5.8 percent annually, and the average dividend yield was 6.1 percent The multiples of earnings (or cash flow) that investors were willing to pay for these early REITs remained steady, providing investors with an average annual total return of 11.5 percent—not a bad performance, considering that from 1963 to 1970 the S&P 500’s total annual return averaged only 6.7 percent Thus, despite their many handicaps, these upstart investments performed quite well

1974, 9.1 percent in 1975, and 11.3 percent by 1979

Not content with such external hardships, the REIT industry was busy creating problems of its own Between 1968 and 1970, with the willing assistance of many investment bankers, the indus-try produced fifty-eight new mortgage REITs Most of these used a

Equity REITs S&P 500

TOTAL ANNUAL COMPOUNDED RETURNS: 1960s

bor-Such stalwart banks as Bank of America, Chase, Wachovia, and Wells Fargo, among many others, got into the act, and it seemed

no self-respecting major bank wanted to be left out of sponsoring its own REIT Largely as a result of these new mortgage REITs, the REIT industry’s total assets mushroomed from $1 billion in 1968 to

$20 billion by the mid-1970s

When the office market—hammered by inflation-driven high interest rates—began weakening in 1973, the new mortgage REITs found that leverage worked both ways Hurt by questionable underwriting standards, nonperforming assets rose to an alarming

73 percent of invested assets by the end of 1974, and share prices collapsed

As a result of their negative experience with mortgage REITs, investors of the 1970s became disenchanted with the entire REIT indus- try for many years thereafter.

Ironically, aside from these mortgage REITs, nonlending equity REITs didn’t do badly during the decade of the 1970s, since many real estate markets remained healthy Federal Realty and New Plan, among others, made their first appearances and these retail REITs did well for investors for many years While asset growth slowed, operating performance was reasonably good During that decade, ten representative equity REITs charted by the Goldman Sachs study turned in a 6.1 percent compounded annual cash flow growth rate, with negative growth in only one year Not surprisingly, those REITs with more than 5 percent insider stock ownership did much better than the others These ten equity REITs also enjoyed

an average annual compounded growth rate of 4.2 percent in their stock prices This, when added to their dividend yields, produced a compounded total annual return of 12.9 percent during the 1970s, which compared very favorably with the total compounded annual rate of return of 5.8 percent for the S&P 500 index

Nevertheless, as the decade drew to a close, REITs were still not