It also should be noted that some of the companies discussed here changed their strategies subsequent to the start of the study period. For example, Simon Property Group, one of the most active acquirors of real estate from 1994 through early 1999, has subsequently adopted a much less aggressive stance. In fact, after certain debt paydowns are addressed in upcoming months, we expect to see Simon join the ranks of companies that are net sellers of properties and sizable buyers of their shares.

How REITs Allocated Capital
REITs grew a lot more than they shrunk (see the three bar graphs on page 64) during the bear market. On average, REITs acquired property equating to 9.3 percent of their beginning-of-the-period total market capitalization, and development accounted for an additional 9 percent growth. This was financed in part with property sales (7.1 percent of assets), but net growth was still 11.1 percent. Completed share buybacks equated to a mere 1.6 percent of the market capitalization of these companies.

Even the group of 31 companies that traded at sizable discounts (more than 10 percent) at the trough of the bear market grew on a net basis. Total investment activity by these companies was 17.3 percent of total market capitalization, and sales were 8.4 percent, resulting in net growth of 9 percent. Here again, share buybacks were small, equating to 1.9 percent of market capitalization.

One type of capital allocation choice that did not show up in this study was the decision to sell an entire company, either to another REIT or to a private entity. The privatization of Irvine Apartment Communities occurred right before the study period, while the deal involving Urban Shopping Centers (see Property, Fall 2000, page 6) occurred after the period. In aggregate, these deals add up to over $5 billion of capital leaving the public sector, and, in our view, they also represent terrific capital allocation decisions by the companies involved. The only other deal of this sort involving a top-39 REIT was Cornerstone Properties’ decision to sell to Equity Office Properties, but because this deal involved two top-39 companies, the net effect was a wash. (We did count the deal in EOP’s acquisition statistics, however.)

Bear Market Strategies Produce a Lot of Diversity
The 39 REITs in this study generally traded in close correlation with the data for our entire coverage universe (see the two line graphs on page 66). As can be seen, there was no point during these 18 months when these companies were, on aver-age, trading at premiums to NAV. In fact, the average discount to NAV during the 18-month period for all 39 companies was 10.5 percent, and over the six months from October 1999 through March of last year, the discount averaged 17 percent. Each of these figures grows by about 3 percent if the group is narrowed to include only the 31 REITs that traded at meaningful NAV discounts during this period.

Any REIT board of directors that was not actively reviewing its corporate strategy during this period was, in our view, asleep at the wheel. REITs that had grown accustomed to capital that was both easy and relatively cheap to obtain were forced to come to grips with the fact that this was no longer the case. While most REITs had to address the capital constraints in one way or another, some chose paths that made considerable sense, while others left us scratching our heads. The different strategies that were implemented can generally be broken into four categories (although some companies don’t fit neatly into any of these boxes). These strategies, as well as our own brief reaction to the merit of each strategy, are outlined below.

Strategy One: Continue to Get Bigger by Buying Property
The most notable examples of companies that implemented this strategy despite the fact that they traded at sizable discounts to NAV are Duke-Weeks Realty, Equity Office Properties, Charles E. Smith Residential, Reckson Associates, Equity Residential Properties, Public Storage, and Simon Property Group. Among the REITs that, though they never traded at big discounts, also employed this strategy were Apartment Investment and Management Co. (AIMCO), General Growth Properties, and Kimco Realty Corp. While most of these companies implemented a program to sell properties to fund a portion of this growth, property acquisitions (inclusive of property acquired in M&A transactions) generally dwarfed property sales. Most of these companies also are notable for the fact that they did not engage in meaningful share repurchase programs, but instead chose to deploy substantial capital into acquisitions.

Our take on this strategy: While we caution against over-generalizations, this strategy remains the hardest for us to understand. To be fair, some of the growth by these companies occurred through mergers in which discounted shares were swapped for discounted shares, minimizing the issue that would arise if the REIT were merely buying properties and issuing stock. That said, most of the companies cited above traded at sizable NAV discounts for an extended period of time, deployed a lot of capital into investments that were fully priced, and allocated very little capital to repurchasing their own discounted shares. We vocally disagreed with this strategy during the bear market, and with hindsight, the cost of the lost opportunity to reap 20-percent-plus returns on share repurchases should, in most instances, be viewed as a misstep.

Strategy Two: Continue to Get Bigger Via Development
The most notable examples (chosen from the group that traded at large NAV discounts) are Federal Realty, Regency Realty, Boston Properties, Liberty Property Trust, and Prentiss Properties. Post Properties and Cousins Properties are prime examples of REITs that did not trade at big discounts.

It is generally fair to say that most of these developers were not growing as quickly as their acquisition-minded brethren, but they were announcing development programs that were not being funded entirely with property sales.

Our take on this strategy: The wisdom of this strategy is harder to gauge. On the one hand, even the most successful development projects generally haven’t generated returns as high as the returns that have been achieved by REITs that repurchased stock. On the other hand, it is very difficult for a REIT to switch back and forth from a development game plan to one that entails partial liquidation. While share buybacks were an excellent opportunity (and both Regency and Prentiss were fairly active repurchasers), it is hard to condemn these REITs for moving forward with their development businesses - especially ones such as that of Boston Properties, which were highly value added. At the margin, however, it may have been preferable to see a bit less development and a bit more buyback activity from this group.

Strategy Three: Recycling Capital
This group continued to make substantial investments in new real estate, but most of it was funded through property sales. Some of these companies also were active share repurchasers. Notable members of this club include ProLogis, AMB Property Corp., and Archstone Communities. It is interesting to note that Archstone was a very aggressive buyer of its own stock, whereas neither ProLogis nor AMB repurchased meaningful amounts of their own stock.

Our take on this strategy:This is a solid business model that should prove effective through both bearish and bullish times. Archstone looks especially shrewd for having repurchased a lot of its stock at cheap prices while continuing to implement this strategy. By not growing their asset bases, these companies are able to keep the value added through development much more meaningful than some of the high-growth companies discussed above.

Strategy Four: Using Property Sales To Fund Stock Buybacks
These companies actually sold more properties than they bought or developed, and they were active repurchasers of their shares. Notable examples are Highwoods Properties, Crescent Real Estate Equities, Camden Property Trust, FelCor Lodging Trust, CarrAmerica, Developers Diversified, and Host Marriott.

Our take on this strategy: The ability to make the best of a bad situation is a desirable attribute, and these companies have all created meaningful value for their shareholders by aggressively repurchasing shares. The chance to repurchase stock at deeply discounted prices was a wonderful opportunity, and these companies should be applauded for taking advantage of it. A more difficult question for some of these companies is, "What is your bull market strategy?"

"Yeah, But Look How Well Our Real Estate Investments Did!"

We usually hear two rebuttals to the data presented here from the companies that continued to grow their asset bases at a rapid clip during the bear market, at the expense of capitalizing on the opportunity to buy back stock. Rebuttal No. 1 charges that Green Street, with the benefit of 20/20 hindsight, is telling REIT execs what they should have been doing. Our response to this criticism is that while we clearly are applying hindsight, we also were very vocal on this issue throughout the bear market. In fact, in a piece we wrote at the end of 1998 (right before the start of the study period), we stated, "We have found ourselves scratching our heads at the fact that a number of REITs have continued to adhere to their acquisitive ways long after the market had sent a strong signal that the vast majority of REITs should abstain, for the time being, from purchasing properties." Rebuttal No. 2 is that the last couple of years have been a wonderful time to invest in real estate; just look at the great results so far. To take this argument even further, a fair amount of the acquisition activity has been in "white hot" markets, and the results to date have been excellent. While good results serve as a decent rebuttal, the folks who cite this as a defense are guilty of using hindsight themselves. We weren’t sure REITs would rebound, and we don’t know a REIT exec who was certain that his investments would rise substantially in value. More importantly, there are very few real estate investments, perhaps excluding development projects in the San Francisco Bay Area, that have generated returns as high as have subsequently been achieved by buying in stock. The reality is that REITs have done well because of the healthy state of affairs in real estate markets, and the best capital allocation for most companies would have been a share repurchase plan.

REITs as a group (see bar graphs on page 64) were somewhat more adept at recycling capital and/or buying in stock in the last six months of the study period than they were through the entire period. Notably, however, they were still much more inclined to grow than shrink, even this late into the cycle. Also, while some companies are only now "seeing the light" (that is, realizing why their stock represents a better buy than more real estate), others are becoming much less aggressive with regard to share buybacks. A strategy predicated on large share buybacks is generally not as interesting now, at today’s higher share prices, as it was a year ago. Companies that have witnessed a narrowing of the public market/private market arbitrage are wise to be scaling back their buyback activity. A strategy that works in one environment may not be appropriate for all environments, and good management teams are adept at shifting gears.

Lessons Learned
It is difficult, and perhaps dangerous, to try to cram corporate strategies into tightly defined boxes. It also is important to note that some of the companies that have implemented strategies we are not enamored with have been solid performers. That said, playing the role of Monday-morning quarterback can be insightful. It is very difficult for us to understand the logic behind some of the strategies that were executed during the REIT bear market. Why a REIT would buy property - virtually any property - when its own stock trades at a 20 percent discount to NAV is a question that we’ve never heard answered satisfactorily.

The data reported here sends a discouraging signal about the ability of REIT management teams to react to the types of environments they will be subject to as public companies. The industry looked pretty smart when the wind was at its back, but when faced with a bear market, most REITs continued to grow as long as they could. The stereotype that real estate folks are, first and foremost, deal makers appears to have been validated. On a more encouragaing note, the industry has made progress toward changing its stripes. Share buybacks by REITs were virtually unheard of until recently, and capital recycling was a novel concept when Archstone and Cousins were about the only REITs using it a few years back. (See the cover story on Cousins beginning on page 14 in this issue.)

As many of the new-to-the-public- market REIT management teams have now witnessed the intelligent strategies implemented by some of the more forward-thinking members of the REIT community, we expect to see continued improvement on this front. Investors will likely become increasingly impatient with the inferior results that have been generated by the REITs most focused on growth, and REITs will continue to improve their capital-allocation acumen.