Real estate: A smart alternative to stocks.

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Author: Kuhn, Susan E.

INVESTING STRATEGY

The financial markets are flailing. Stocks are seesawing, bonds are acting badly, and the prospects for international investments are wavering under a strengthening dollar. Fears of inflation are growing as commodity prices rise and the economic expansion ages. With bargains getting harder to find, smart investors are turning to real estate--for gains and portfolio protection. Morgan Stanley investment strategist Barton Biggs recently cut his global equity exposure to 56%, while recommending a 10% allocation to real estate. On the left coast, San Mateo, California, money managers Bailard Biehl & Kaiser recommend a 20% commitment.

Most of us haven't considered investing that much in real estate, but the high yields, steady returns, and financial safety net are hard to ignore. Better, recovery from the real estate lows of the late 1980s still has years to run. Says Biggs: "We'll have high returns in commercial real estate, well in excess of their 8% yield." Adds Art Micheletti, Bailard's chief investment strategist: "Real estate is a nice anchor, like a cash position. We think it looks attractive for the next four years."

There are plenty of ways to invest right now, whether you want to buy a building outright or invest a few dollars in real estate investment trusts. Called REITs, these bundled properties pay out cash from rents and trade like stocks. For the first time since 1978, cash yields generated from real estate are exceeding yields on ten-year Treasuries, calculates real estate research firm LaSalle Partners. Total returns, which include yields plus share price gains, are expected to average 12% per year in the future. Says Jeffrey Everett, manager of the top-performing Templeton Real Estate fund, a global fund with 35% of its assets in U.S. REITs: "Now is the perfect entry point, since the popularity is not there yet and the real estate market is undervalued." Morgan Stanley estimates that REITs on average are trading at 10% discounts to the market value of the properties they hold.

So far this year, REITs have been overlooked in favor of the rampant stock market; they rose 2.3% in the first quarter, vs. 5.4% for the S&P 500. In 1995 most REITs had a similarly tough time keeping pace, though some sectors surpassed equities in the dark days of 1994 (see table). Among the groups with momentum, REITs specializing in hotels, up 10% in the first quarter, remain on a roll. Salomon Brothers analyst John Litt reports that U.S. lodging demand rose 3.1% annually between 1991 and 1995, while total supply increased by only 1.4%.

REIT managers are keen on full-service hotels like Marriott or Hyatt. Patriot American Hospitality, a Dallas-based owner of 31 such hotels, has little debt and is acquiring properties below their replacement costs. Keith Pauley, co-head of investments for LaSalle, estimates the REIT, selling for $27.75, is worth $29. Plus, it's paying a dividend of 6.9%, and cash flow is growing 20% per year.

Two other hotel REITs worth checking into are FelCor Suite Hotels, an operator of Embassy Suites, and Starwood Lodging.FelCor's REIT zoomed 43% last year but could return 20% more, says Franklin Real Estate Securities fund manager Matt Avery. FelCor, based in Irving, Texas, recently sold for $29.25, with a 6.3% yield. Starwood Lodging is a unique two-for-one investment: one part is the REIT, which owns the hotels, and the other is the corporation, which runs the business. Starwood's soon-to-be 53 properties include everything from Marriott to Embassy Suites, making it the largest U.S. hotel REIT. Based in Los Angeles, Starwood sold recently for $33, with a 5.7% yield. Robert Frank, head of real estate securities research at Alex. Brown & Sons, believes it could return 12% over the next 12 months.

The apartment market is also soaring, particularly in San Francisco--thanks to expensive property, tricky hilltop construction, rents rising at twice the national rate, and vacancies as low as 1%. Bay Apartment Communities, headquartered in San Jose, is the REIT to buy; at $24.38, the dividend yield is 6.6%. Spieker Properties, which owns suburban offices and industrial properties, is another fine California REIT. Tim Reynolds, manager of the United Services Real Estate fund, predicts a 15% annual return over the next two years. The REIT was recently $26.13, yielding 6.4%.

TOTAL RETURN TO INVESTORS

Property                       Projections   Recent
type           1994     1995   for the next  dividend
                               12 months     yield

Hotel         -10.6%    30.8%     17.6%       7.5%

Office         2.9%     38.8%     16.6%       5.9%

Apartment      2.4%     12.3%     19.2%       7.5%

Industrial     17.7%    15.9%     15.3%       6.8%

Diversified   -7.3%     21.2%     14.9%       7.3%

SOURCES: NAREIT; ALEX. BROWN & SONS

PHOTO (COLOR): Bay Apartments can't build them fast enough.

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By SUSAN E. KUHN