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TrizecHahn To Become U.S. REIT
TrizecHahn Corp. has unveiled its long-awaited reorganization, a plan to form a publicly traded U.S. REIT holding all of the Toronto-based company’s U.S. assets. The company said the reorganization’s goal is “to unlock shareholder value by focusing on the company’s core U.S. office business while divesting its other holdings.” TrizecHahn derives more than 90 percent of its rental income from its American office properties.

Under the plan, U.S. stockholders would receive one share in the new REIT for every share they own in the current company. The remaining shareholders—most of them are Canadian—will receive, also in a one-for-one swap, shares in a new Canadian company, Canco, which will own about 40 percent of the REIT. The reorganization is expected to close late in next year’s first quarter.

Tax considerations played a key role in shaping the plan. U.S. tax law imposes a 35 percent capital-gain levy on the sale of U.S. real estate by a foreign corporation; such a tax, management believes, would no longer apply to asset sales by a U.S. REIT. In addition, distributions to U.S. stockholders in the new REIT won’t be subject to cross-border withholding.

In announcing the restructuring, TrizecHahn revised its earnings forecast for next year. It is now projecting funds from operations of $2.68 per share for 2002 vs. a pro forma projection—that is, assuming the restructuring were already in place—of $2.49 per share for this year.

The new REIT’s portfolio will comprise 76 office properties totaling 49 million square feet; most of the holdings are in the central business districts of seven major cities. The small nonoffice part of the portfolio, consisting of retail and entertainment properties, will be ticketed for sale.

Heritage Files Its IPO
The much-anticipated IPO filing for Heritage Property Investment Trust finally came early in September. As our sister publication, Realty Stock Review Online, had reported previously, the $420 million offering will be lead managed by Merrill Lynch & Co. The REIT would trade on the New York Stock Exchange. Its proposed ticker is HTG.

In its S-11, Heritage, a private UPREIT, describes itself as an entity that acquires, owns, manages, leases, and redevelops primarily grocery-anchored neighborhood and community shopping centers in the Eastern and Midwestern United States.

“We are one of the largest owners and operators of neighborhood and community shopping centers in the country, with a portfolio, as of June 30, 2001, of 140 shopping centers totaling approximately 22.7 million square feet of gross leasable area located in 26 states. We also own seven office buildings and 11 single-tenant properties. Our shopping center portfolio was approximately 93 percent leased as of June 30, 2001,” the filing states.

Heritage is a Maryland corporation that commenced operations in July 1999 as the successor to a company formed in 1970 to manage the real estate investments of NETT (New England Teamsters and Trucking Pension Fund). According to the S-11, in 1970, NETT began to invest in real estate, primarily focusing on strip-center retail neighborhood and community shopping centers.

“In July 1999, recognizing that its real estate portfolio had reached its target allocation size, NETT made a strategic decision to contribute its portfolio of 60 properties into a newly formed REIT, Heritage Property Investment Trust. At our formation, The Prudential Insurance Company of America also made an equity investment in Heritage,” the S-11 explains.

The Heritage S-11 goes on to cite the company’s track record. “During NETT’s fiscal years from 1991 to 1998, management generated average annual income returns of 10.6 percent and average annual unrealized increases in property market values of 2 percent, for a total average annual return of 12.6 percent. Over the same time period, according to the National Council of Real Estate Investment Fiduciaries, or NCREIF, retail properties in the United States which report data to NCREIF generated average annual income returns of 7.6 percent and average annual unrealized decreases in property market values of 3.2 percent, for a total average annual return of 4.4 percent”

On September 18, 2000, Heritage acquired Bradley Real Estate for aggregate consideration of approximately $1.2 billion. The Bradley portfolio consisted of 97 shopping centers with a total of approximately 15.3 million square feet of gross leasable area located in 15 states, primarily in the Midwest.

Market veterans said they expect Heritage to offer a dividend yield in the 8 to 9 percent range. When the deal prices, they stressed, depends on market conditions. However, sources said they believe that Heritage and its underwriters hope to be able to do the deal in November.

Felcor and MeriStar Call Off Deal
The events of September 11 claimed a casualty in the REIT market: the merger of two big hotel companies.

FelCor Lodging Trust, the nation’s second largest hotel REIT, and MeriStar Hospitality Corp., the third largest, called off their marriage, citing “adverse changes in the financial markets” following the terrorist attacks. “The termination of this merger is the result of the recent tragic events and their subsequent adverse impact on the financial markets,” said Thomas J. Corcoran Jr., president and CEO of FelCor. “A lot of dedicated people worked very hard on this transaction, but Paul Whetsell of MeriStar and I have agreed to focus now on our respective businesses.”

Irving, Texas-based FelCor owns 185 hotels with nearly 50,000 rooms and suites and is concentrated primarily in the upscale and full-service segments. It owns the largest number of Embassy Suites, Crowne Plaza, Holiday Inn, and independently owned Doubletree-branded hotels. Other brands in its portfolio include Sheraton and Westin.

Washington, D.C.-based MeriStar owns 112 mostly upscale, full-service hotels in major market and resort locations with 28,617 rooms in 27 states, the District of Columbia, and Canada. Its brands include Hilton, Sheraton, Marriott, Westin, Radisson, and Doubletree.

REITs With High Dividends Produce Top Total Returns
How do dividends paid by REITs compare with the total return—dividends plus stock-price appreciation—delivered to those companies’ shareholders? Analyst James W. Sullivan at Prudential Financial says his firm’s clients were asking just that, so he and his staff decided to find out. The answer: REITs with the greatest growth in payouts produced the best total returns.

The Pru researchers studied industry dividend performance over the five-year stretch from 1996-2000. They started out with a sample of the 128 largest property-owning REITs, which shrank to 102, thanks to mergers, conversions to non-REITs, and payout eliminations.

Over the span, the analysts concluded, 75.5 percent of the companies raised their dividends, with the payout hikes averaging 4.38 percent. Further, the Pru team discovered, companies that lifted their dividends also increased total return in each of the five years. And in every year except 1998, the top quintile, or 20 percent, of dividend boosters delivered above-average total returns (see table below). Over the five-year period, moreover, double-digit dividend growers produced an annual average total return of more than 20 percent, compared with an average total return of 17.4 percent for the top quintile and 12.2 percent for the overall sample.

Chart Dividend growth, of course, isn’t the only contributor to rising total return. The Prudential analysts looked at how increases in dividends compared with increases in estimates of funds from operations for the sample companies over the five-year period. The analysts found “estimate revision has had a significantly higher correlation for the period. … However, in alternate years, dividend growth has outperformed. In 1996, 1998, and 2000, estimate revision had a much higher correlation; whereas, in 1997 and 1999, dividend growth had a slightly higher correlation.” So, “to determine those companies that have the likelihood of announcing the biggest dividend increases, we suggest investors focus on those companies with the combination of the lowest current payout ratios and the higher projected growth rates.”

As an aside, but noteworthy in an investment climate focusing ever more intently on yield (See “Rock Solid: The REIT Dividend Story,” Property, Sept./Oct. 2001, page 20), the analysts observe the payout ratio has been declining over the years, to 66.3 percent of FFO in 2000 from 86 percent in 1993, and over the five years of the firm’s dividend study, the dividend growth rate compared with growth in FFO of 10.9 percent. They figure, though, “that the industry payout ratio can decline to less than 50 percent before the industry reaches the level where dividends approach the minimum payout levels stipulated in REIT legislation.” That level is 90 percent of otherwise taxable income.

As the upshot of their study, Sullivan and his Pru colleagues counsel, “A disciplined investment strategy that focuses on only those companies likely to deliver above-average dividend growth should pay off in substantially higher excess returns.”

Sector Watch
San Francisco Bay Area Multifamily Remains Unsteady
Owners of apartment developments in the San Francisco Bay Area and elsewhere in Northern California thought they had survived the worst of the fallout from the state’s energy problems and soaring joblessness tied to woes in the technology sector. But the latest readings from the region indicate that the apartment market there has not yet stabilized.

UBS Warburg reports that apartment REITs with properties in the Bay Area had been upbeat in their conference calls with analysts following the release of second quarter results. Officers of the companies believed “rent and occupancy declines had begun to stabilize,” according to a recent research note from the securities firm. But the region’s apartments have continued to suffer from falling rents and occupancies, according to surveys by research firm Axiometrics Inc., cited by UBS Warburg. The most recent survey, conducted in August, showed rents at apartments owned by REITs with properties in San Francisco tumbling by 8.3 percent from mid-May to mid-August on a 0.6 percent drop in occupancies.

Salomon Smith Barney analysts also have been conducting surveys of multifamily markets in California, and they, too, have been surprised by the recent reversal of what apparently had been a stabilizing trend in the northern part of the state. According to a research note from analyst Jonathan Litt and his staff, rent declines in the region had flattened from a 6.8 percent dive in June to 0.7 percent in August. But then the firm found that rents in Northern California fell 4.5 percent during September.

The outlook doesn’t look encouraging. According to UBS Warburg, the supply of new apartments coming on line “has only slightly moderated” while year-over-year growth in employment has plunged 97 percent in the region.

Bleak Outlook for Lodging Sector
A little more than a week after the terrorist attacks on the World Trade Center and the Pentagon, a major hotel REIT, Host Marriott, announced it would take the events into account in determining its fourth quarter dividend. The company will not be alone.

The hotel industry, which had already been suffering from a deteriorating economy, faces severe difficulties in the aftermath of the attacks as travelers, especially those who fly, decide to stay close to home. PriceWaterhouseCoopers now looks for a decline of 7 to 11.5 percent in revenue per available room, or RevPAR, for the remainder of the year. Smith Travel Research looks for a 10 percent drop in RevPAR for the rest of 2001. And Wall Street analysts are weighing in with gloomy outlooks on the hotel industry, including the threat that many lodging REITs will violate covenants in their loan agreements. This could result in dividend cuts and outright suspensions of payouts.

Green Street Advisors, an institutional research firm specializing in real estate stocks, notes that the attacks have inflicted “damage to the psyche of both domestic and international travelers” in the United States, and that “fly-to hotels”—upscale properties in cities and at airports—would suffer more than “drive-to hotels” in smaller communities and along highways. The firm formulated three scenarios in assessing the industry’s prospects.

The first assumes the events of September 11 were an isolated episode, resulting “in a forceful yet measured response by the United States and its allies.” The U.S. economy would slip into a short-term recession, resuming normal growth in next year’s second half. Airlines would continue flying; travelers would feel safe again. RevPAR for full-service, upscale hotels would post significant declines for the rest of this year, show growth keeping pace with inflation next year, post growth above inflation in 2003, and generate 90 to 95 percent of previously projected levels in 2004.

In the second scenario, Green Street assumes that a clear U.S. victory over global terrorism would be elusive, with the global economy staying in recession through the second half of next year before resuming moderate growth. The traveling public would remain spooked by fears of continued terrorism, dealing a severe blow—a 30 percent year-over-year decline in the demand for hotel rooms through the middle of next year, a lingering impact through the end of 2003, and, finally, recovery to 1999 levels in 2004. Operators would be unable to cut costs enough to match revenue declines, and operating margins would wither. Plans for new hotels would be put on hold, and pending new management contracts and franchise agreements would dry up.

In Green Street’s most depressing scenario, the firm assumes that terrorism in the United States would continue as consumer confidence drops and the world plunges into a deep and long recession. Travel would suffer correspondingly, and hotel demand would tumble 35 percent from 2000 levels for the next year, gradually stabilize, and resume modest growth in 2003. RevPAR would be equivalent to that of 1995-96. Loan defaults would leap, though most defaulting hotels would stay open because they can cover operating costs. Hotel construction would halt.

Based on the second scenario, of the stocks it covers, Green Street recommends buying MeriStar Hospitality, Hilton Hotels, and Starwood; holding Host Marriott; and selling FelCor Lodging and Extended Stay America.

First Union Securities has created three scenarios to assess the risk of covenant violation by property stocks it follows. In the first, earnings before interest, taxes, depreciation and amortization, or EBITDA, would fall 10 percent from this year’s third quarter through next year’s second quarter. The second scenario envisions a 20 percent drop in EBITDA for the same span. In the third scenario, the firm assumes EBITDA for each of the quarters from this year’s third quarter through the second quarter of 2002 would be 80 percent below the corresponding year-earlier period—and even lower, if the EBITDA in its corresponding period in any of the past three years is lower.

Analysts at First Union say lenders will be least forgiving of violations of EBITDA-to-interest covenants—the “Will I get paid?” provisions in loan agreements. Under the firm’s “stress testing” of companies in its coverage universe, in which it assumed that the earlier a company violated a covenant the earlier it would default, it listed as high risk MeriStar Hospitality, LaSalle Hotel Properties, Jameson Inns, and Boykin Lodging. In the moderate-risk column, it put Host Marriott, Felcor, Equity Inns, RFS Hotel Investors, and Winston Hotels. First Union recommends the two hotel REITs slotted in the low-risk category: Hospitality Properties Trust and Innkeepers USA Trust. For both, write analysts Jeffrey J. Donnelly and Eric Rothman, “The risk of default and change of dividend policy is negligible.”

Capital Markets
AvalonBay Stock Redemption
AvalonBay Communities, with interests in 139 apartment complexes in 12 states and the District of Columbia, will redeem all outstanding shares of its 8.96 percent Series G cumulative redeemable preferred stock on October 26 at a price of $25 per share, plus $0.4418 in accrued and unpaid dividends to the redemption date, for an aggregate redemption price of $25.4418. Also subject to redemption are securities previously exchanged for the Series G preferred: Avalon Bay Communities Series G cumulative redeemable preferred stock and Avalon Properties 8.96 percent Series B cumulative redeemable preferred stock.

Public Storage Redeems Stock
Public Storage, a Glendale, California-based REIT that develops and owns storage facilities, is redeeming all 6,750,000 depositary shares representing interests in its 8.45 percent cumulative preferred stock, Series H, at a redemption price of $25 per share plus a sum equal to all accrued and unpaid dividends from October 1 through October 5, the redemption date. To redeem the shares, the company intends to use the proceeds of some $500 million from the public offering of a new series of 20,000,000 depositary shares, each representing 1/1,000 of a share of 8 percent cumulative preferred stock, Series R. Salomon Smith Barney was lead underwriter.

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