Winter 2000
	Cover Story REITs at the Millennium Industry veterans look into their crystal balls. Where are REITs headed? Company Spotlight Can Crescent Get Its Groove Back? John Goff is working to restore Crescent Real Estate Equities’ reputation as a REIT that "gets it." Property Fundamentals Lack of Correlation J.P. Morgan’s Michael Giliberto provides answers to the age-old question, "Are REITs really real estate?" Awards Spotlight Best & Brightest Realty Stock Review’s eighth annual awards presentation recognized the top vote getters in a number of categories, including outstanding analysts, CEOs, and CFOs. Voters also chose the industry’s man of the year and men of the decade. Investment Analysis Applying MPT to REIT Portfolios Careful portfolio construction can make or break the performance of a pool of assets. Investment Fundamentals The High Cost of Real Estate Ownership Swapping net income for FFO might not be such a bad idea after all. By The Numbers A Fund Manager’s Worst Nightmare If it’s true that what doesn’t kill you makes you stronger, real estate fund managers may be some of the strongest folks around. Point Of View REITs and Rights Plans Criticism of REITs that adopt rights plans is simply misplaced. Investment Spotlight Spooked What happens when more than a dozen REIT UITs start unwinding in the midst of the worst bear market in a quarter of a century? The New Economy When Worlds Collide The Internet will provide investment opportunities for innovative office and retail real estate companies that embrace the changing landcape. Investment Insight LBO Math The market is beginning to understand that LBO valuation does not equal net asset value. Parting Shot Coming of Age REITs have evolved from pools of properties to focused real estate operating companies. Newsline Captec Wants to Shed REIT Status Investor's Guide Questions Back Issues Feedback

by Barry Vinocur
Illustration by Mark Kseniak

It isn’t as if real estate fund managers expected 1999 to be a banner year, but they sure didn’t figure it would be déjà vu all over again either. Heading into the last two weeks of the year, property-linked stocks were getting hammered. To add insult to injury, investors were bailing out of the funds in droves. According to AMG Data Services in Arcata, California, through December 15, real estate fund assets had shrunk by just shy of $1.5 billion this year. Of that, again according to AMG, just over $1 billion was the result of net outflows from the funds

Putting your finger on what ails property-linked stocks is far from easy, however. As fund managers are quick to point out, there’s a disconnect between property fundamentals - unusually robust for the late innings of a real estate cycle - and stock prices. Then again, you cannot fight the tape. Through December 15, the Morgan Stanley REIT Index was in the red. Since it’s a total return index, the damage was worse than it appeared on its face - a negative 11.95 percent total return. If you peg the average REIT dividend yield at roughly 9 percent, that means stock prices were down roughly 20 percent this year. After last year, the worst in a quarter of a century for REITs (the Morgan Stanley index was down 16.9 percent last year), it’s no wonder investors are throwing in the towel.

Though it’s unlikely that REITs will finish in the black this year - making it only the second time in 25 years that REITs have posted back-to-back years of negative total returns - fund managers did get a shot in the arm on December 17. That morning, The Wall Street Journal reported that tucked in a 20-year-old wallet belonging to famed investor Warren Buffett that was auctioned off for charity was a stock tip. The stock tip was First Industrial, a REIT headquartered in Chicago. Over the next two days, the Morgan Stanley REIT Index soared by roughly 5 percent. (First Industrial was

up approximately 7 percent on December 17.) Ironically, it was the second time in 1999 that Buffett had ridden to REITs’ rescue. The first time was in the spring when he filed 13-ds on two REITs. First up was Tanger Factory Outlet Centers, and later, Town & Country, an apartment REIT. Though it’s too soon to know whether this Buffett-induced rally will suffer the same fate as the spring one - it fizzled after roughly a four-week run - fund managers were enjoying the ride as we went to press.

Suprisingly Positive
If there was a surprise at the 1999 National Association of Real Estate Investment Trusts’ convention it was that all things considered, REIT managements were, for the most part, upbeat. Make no mistake, people weren’t swinging from the chandeliers, but no one had to suggest removing all sharp objects from the tables, either.

There was a good deal of talk about how the public market "just doesn’t get it." Nevertheless, increasingly REIT managements are accepting the fact that whether or not the public market "gets it," unless they want to take their companies private, they’ll have to play the hand that they’re dealt.

Does the public market "get it?" Realty Stock Review, one of Property’s sister publications, thinks it does. "So there’s no misunderstanding, we don’t agree that the public market doesn’t ‘get it.’ As we have noted numerous times previously, though the public market tends to overshoot in both directions - and significantly, at times - it rarely gets it wrong. The problem is that it almost always takes years, if not decades, to appreciate what the public market understands in real time," the newsletter wrote recently.

That said, there’s no question that this time it really is different. Heard that before? Haven’t we all? But this time it really is different. Just how different is captured in a passage in Michael Lewis’ new book, "The New, New Thing: A Silicon Valley Story."

"In the second part of the 1990s, Silicon Valley had the same center-of-the-universe feel to it as Wall Street had in the mid-1980s. There was a reason for this: It was the source of a great deal of change. Up until April 4, 1994, Silicon Valley was known as the source of a few high-tech industries, and mainly the computer industry. On April 4, 1994 Netscape was incorporated. Suddenly - as fast as that - Silicon Valley was the source of changes taking place across the society. The Internet was a Trojan horse in which technogeeks entered all sorts of markets previously inhospitable to technogeeks. Wall Street, to take just one example, was turned on its head by new companies and new technologies and new social types created just south of San Francisco. The financial success of the people at the heart of this matter was unprecedented. It made 1980s Wall Street seem like the low-stakes poker table. As yet, there is no final reckoning of the wealth the Valley has created. Hundreds of billions of dollars, certainly; perhaps even trillions. In any case, ‘the greatest legal creation of wealth in the history of the planet,’ as one local capitalist puts it."

The wealth Lewis writes about has touched millions of investors in true "trickle-down fashion." That wealth has changed the lives of millions of investors. Aside from the obvious impact this wealth creation has had and is having on their lives, it is having a side effect that even today may not be fully appreciated by everyone.

Put simply, millions of investors have had their investment thermostats reset. Think about it. The pool of so-called income-oriented investors is smaller today than it has been in many, many years. Countless investors who, absent the dot-com frenzy, might have been poring over newspapers searching for yield, are today vacationing in faraway places. Their trips have been financed in large measure by the greatest bull market in the history of the world.

In the end, investors’ heads are no longer turned by the prospect of 10 to 12 percent total returns year-in and year-out. There’s no way to know how long this condition will last. It could take years, possibly even a decade or more. Then again, it could turn on a dime tomorrow. When it does, investors may take notice of something that John Neff, the legendary value investor who until his retirement in 1995 oversaw the phenomenally successful Windsor Fund, wrote in his recently published book, "John Neff on Investing." Writing about REITs, Neff stated, "This area has been bruised, maligned, overlooked, and misunderstood."

Looking at Funds
As of December 16, only six of the 62 real estate funds tracked by our sister publication, Realty Stock Review, (see page 53) were in the black. The best performer of the lot was Morgan Stanley’s Asia fund, which was up 22.9 percent. Not far behind it was Cohen & Steers Special Equity, a fund that focuses on domestic property-linked stocks. It was up 20 percent. In third place was Fidelity Real Estate High Income I, up 7.6 percent. Fourth place belonged to Security Capital Europe RE Shares with a 3.9 percent total return. In the number five spot was Dreyfus Real Estate with a 2.3 percent total return. In the sixth spot was Third Avenue Real Estate with a 1.4 percent total return. Vanguard’s fund, which is an index fund that tracks the Morgan Stanley REIT Index, finished well below the middle of the pack with a negative 11.3% total return.

If you focus on risk-adjusted returns, the best performing fund (among those with a track record long enough to be included in Morningstar’s data survey), was Fidelity Real Estate High Income (see table above). In the number two and three spots were funds managed by Delaware. Next was Morgan Stanley’s U.S. institutional fund. Rounding out the top five funds, ranked by Sharpe ratio, was Columbia Real Estate Equity.

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