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 Ruth Sofair Ketler

It doesn’t take much to spook the real estate investment trust market these days. More than two years into a bear market - the worst in roughly a quarter of a century - investors in REIT stocks are on edge. So when analysts at Legg Mason in Baltimore pointed out in the fall that a number of REIT unit investment trusts would begin unwinding soon, it touched off a good deal of discussion about the potential impact of those "unwindings." For a while that’s all there was, talk. More recently, however, two groups produced in-depth reports on REIT UITs, including an assessment of the impact on the REIT market of the unwinding of the UITs. The first published report was by Jim Sullivan and his colleagues at Prudential Securities. The Prudential study was followed by a report by Kevin Comer and his colleagues at Deutsche Banc Alex. Brown.

Collecting data on REIT UITs, as Sullivan and his colleagues noted in their report, is far from an easy task. In some instances, the sponsors of the UITs weren’t exactly forthcoming. Despite the obstacles, Sullivan’s and Comer’s groups not only provide their respective takes on the potential impact of the unwinding of the REIT UITs, but also, and most important, they back up their conclusions with a lot of data.

Our sister publications, Realty Stock Review and Realty Stock Review Online (www.realtystockreview.com), were never major fans of REIT UITs. Among their concerns (on the front end, we’d add) were that to create the so-called no-load UITs many (though not all) of the UITs bought stock directly from the companies rather than on the open market. Buying the stock directly from the companies allowed the sponsoring firms to capture the "underwriter’s discount," thereby creating a no-load UIT. Another of their concerns was that some of the REIT UITs, in their view, were subinvestment grade. In other words, rather than putting together a basket of REITs based solely on their investment merit, some sponsors favored their banking clients.

Finally, Realty Stock Review and Realty Stock Review Online worried that depending on the state of the REIT market at the time the UITs started to unwind, the supply of stock left in the UITs when the unwinding took place (investors can and have sold prior to "maturity") could create an overhang problem that would further depress stock prices.

As noted, what’s been missing from recent "discussions" of the potential impact of unwinding REIT UITs was data. Though the data isn’t perfect - as the Prudential analysts note in their report, "… not all sponsors were cooperative ..." - any shortcomings are unlikely to have had any significant impact on either report’s conclusions.

As both reports demonstrate, there are a number of ways to slice and dice the available data on REIT UITs (see tables in this article). However, the most important data - relative to the impact the unwinding of the REIT UITs might have on stock prices - is captured by looking at several factors: first, when the UIT terminates; second, how much of each participating company’s stock is in the UIT; and third, how long it would take to sell off that stock assuming normal trading volumes. Both the Prudential and the Deutsche Banc analysts looked at each of these factors.

In their report, the Prudential analysts noted that Smith Barney launched the first REIT UIT in the third quarter of 1997. That December, Legg Mason and Prudential Securities launched their first REIT UITs. Over the following five months, Sullivan and his colleagues pointed out, an additional 11 UITs were completed. All in, the industry raised approximately $3.5 billion through UITs.

"Although there were variations, the funds were designed to offer investors a packaged REIT product that featured lower costs. There were no brokerage commissions to the buyers on the initial investment because the companies paid a spread to the bankers that sponsored each trust. [As noted, in most - but not all - cases, the UITs bought newly issued shares.] Moreover, ongoing fees for each trust were relatively low since the trusts were not actively managed. From the issuer’s standpoint, UITs had appeal since capital could be raised without the need for a time-consuming road show, which also could put pressure on the share price. Moreover, many issuers were sold on the idea that the distribution quality should be relatively good since the trusts were designed to be multiyear vehicles, although investors did have the option to redeem their interest. All of the trusts were for periods of two, three, or four years. Upon the end of the term, the trusts would be terminated and investors would be offered their pro-rata share of cash or securities. The trustee was provided with 10 days in which to sell the shares required and make a final distribution to the investors," the Prudential analysts wrote.

According to the Prudential analysts’ calculations, as of early November, the 14 UITs they have data for had $1.6 billion in current share value spread among 69 different companies. Those UITs are scheduled to terminate over a two-and-a-half-year period beginning in December 1999 and ending in April 2002.

"The redemption schedule [see table below] looks like a forward equity calendar that can only lead to additional pressure on the prices of those REITs in the UITs. However, that conclusion ignores the fact that all of the UITs have been subject to a considerable amount of redemptions since inception and are likely to have additional redemptions prior to the scheduled termination dates. We estimate that, on average, the UITs have already had approximately 30 percent of their interests redeemed. That more gradual pace of selling should result in a more orderly market in the shares than the schedule alone would indicate," the Prudential analysts pointed out.

Nevertheless, as Sullivan and his fellow analysts noted, REIT portfolio managers "may take little comfort from that interpretation." They further explain that the supply of REIT shares in UITs represents equity that must be sold over the next 30 months and new capital must be in place to absorb that supply. "In the face of steady declines in assets for some of the major REIT mutual funds, the natural tendency is to look upon UIT redemption as the equivalent of the sky falling. But the current value of REIT shares held by the UITs represents monthly average volume of only $53 million if spread over the next 30 months."

The Prudential analysts estimated (November 1999) the then current industry float at approximately $110 billion with an implied market cap of $125 billion. "Given a weighted average current yield of 8.7 percent, gross dividends are just under $11 billion annually, and a very modest dividend reinvestment rate should easily absorb the supply that the UITs should be releasing onto the market. Announced share buybacks," they added, "are another source of demand."

In prior research reports, the Prudential analysts went on to state, they had suggested that the marginal money that could make a positive difference in the market is the non-real estate dedicated value players as well as the pension fund money that has real estate allocations. "The pension fund money is certainly sensitive to the current attractive net asset values at which REIT shares trade, and, in a rational market, [pension funds] would buy REIT shares rather than real estate directly in the private market. We believe that this is happening and is likely to continue.

"The total value of the equity REIT industry compared with the value of UIT holdings," the Prudential analysts wrote, "ignores the fact that many REITs did not issue any shares to UITs, while some REITs issued a relatively substantial amount of shares to UITs. Moreover, some REITs participated in only one UIT while others participated in several whose redemption periods are spread over a long period of time."

Two UITs terminate in December 1999. "Only two REITs, Brandywine Realty and Commercial Net Lease, have shares equal to more than five days of trading volume (based on the 30-day trailing average daily volume) in the UITs scheduled to terminate in December. Other examples worth noting in the first round of scheduled terminations include Burnham Pacific, which we estimate has shares equal to about 10 days of volume in one UIT scheduled to terminate in March of 2000, and Kilroy Realty, which has shares equivalent to 12 days’ volume in two UITs that are scheduled to terminate between the middle of February and the end of March in 2000," the Prudential analysts wrote.

Though Sullivan and his fellow analysts don’t anticipate any frenzied selloffs for any of the 69 listed companies with shares in UITs, they added that some weakness is likely, and "certain out-of-favor names may be more vulnerable."

In the end, both Sullivan’s and Comer’s groups came to the same conclusion: Concerns about the unwinding of REIT UITs, though understandable, have been overblown. "We believe that wholesale price weakness because of UIT participation is unlikely," the Prudential analysts concluded.

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