REAL ESTATE IS A BUYER'S MARKET.

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Author: Hylton, Richard D.

WHAT'S the smart money buying? Look at George Soros, smart money personified these days: He's buying real estate. Soros's Quantum Realty Fund, a partnership with busted property guru Paul Reichmann, recently plunked down $634 million of cash and debt for some of Travelers Insurance's foreclosed office buildings and troubled mortgage loans.

Soros isn't alone. Wall Street investment banks have raised about $4 billion for private funds to snap up distressed properties at deep discounts. Lively demand is pushing up prices for real estate sold by the Resolution Trust Corp. The public is devouring new offerings of real estate investment trusts (REITs) while sending prices of existing ones to all-time highs.

After nearly four years in virtual free fall, commercial real estate seems finally to have hit bottom -- a deep, deep bottom. Initial public offerings of REITs proliferated this year, with 26 IPOs raising $4.3 billion through August. REITs are publicly traded companies that invest in real estate and must pay out at least 95% of their taxable income as dividends.

For investors, the choice of REITs is about to grow larger still. Some 19 REIT IPOs valued at about $5.5 billion are in registration with the SEC, and many more are being planned. Mark O. Decker, president of the National Association of Real Estate Investment Trusts (Nareit), says the industry has grown more in the past 24 months than in its preceding 31 years of existence. ``We're still less than 1% of the domestic real estate market, at $30 billion in assets,'' he says. In five years he expects the industry to grow to more than $100 billion in assets.

With money market funds paying all of 2%, those new offerings are being snapped up more for their dividend yields than for the value of their real estate portfolios. Yields averaged about 7% in this year's first half, says Nareit. But that's only a small part of the payoff. Total returns for so-called equity REITs -- the large majority -- averaged 17.6% for the first half (excluding eight health care REITs, which are plays on the health care business as much as real estate investments). That total return is 3.6 times the S&P 500's.

What's going on? ``Real estate as an asset class is underpriced today,'' says Mike Kirby, a principal at Green Street Advisors, a REIT research firm in Newport Beach, California. That doesn't mean that commercial real estate markets are perky. Thousands of unneeded office buildings still stand empty and forlorn, and consumers are not back to their free-spending ways at the malls. It's just that prices have at long last fallen so far -- to about half their late-Eighties level -- that they're finally attractive relative to other investments.

So which REIT is right for you? In deciding, focus on the management and its track record handling the type of property the REIT company owns. Also check whether there are conflicts of interest between managers and public shareholders. The managers are generally developers who have sold an interest in their properties to the REIT. If the developer bought a property at a low price, then sold an interest to the REIT at a higher price -- a common situation -- the developer may avoid selling it later to a third party because he would face a higher tax liability than the other shareholders.

Stay away from REITs that are little more than exit strategies for developers in need of capital. Top managers should hold big stakes in the REIT's shares. An independent board, fixed-rate (not floating) debt that is 30% to 40% of market capitalization, and geographical focus are also good signs. A rising market tide may lift all boats, but if short-term interest rates start rising as well, some lower-quality boats could suddenly be underwater.

``You're seeing a better quality of company coming to market now,'' says Green Street's Kirby. Among those he favors are Taubman Centers, Carr Realty, Manufactured Home Communities, and Post Properties. ``They are trading at 10% to 15% premiums to current value on average, but I think it's warranted,'' he says. ``If prospects are good for substantial growth, then why should you focus on just current value?''

Jon Fosheim, another principal at Green Street Advisors, cautions that as REIT stocks outpace the broader market, bargains disappear fast. With investors pushing prices of many of the best-managed REITs into the stratosphere, Fosheim sees opportunity in underpriced second-tier companies. He thinks that Sizeler Property Investors, recently at $13.63, should be at $15 to $16, and that Crown American Realty Trust, recently at $16.25, could go above $20.

Taubman Centers was last year's most watched REIT offering. The nearly $300 million IPO pioneered a structure that has become successful if controversial: the umbrella partnership REIT, or Upreit. This is basically the combination of a real estate partnership with a REIT; instead of the REIT owning properties directly, it owns an interest in a partnership that owns the properties and a management company. Why such contortions? Tax laws you should be glad not to know about let the partnership raise financing through the REIT and avoid taxes. The structure involves potentially higher fees because of its extra layer of management, and the partners' interests could conflict with the shareholders'. Nonetheless, some of the year's best performers have been Upreits.

Taubman Centers owns one-third of one of America's premier portfolios of super-regional malls. They are among the most profitable of their type, and most analysts, including some who were critical of the complex IPO, are touting the shares, which have risen about 40% and generate a 5.7% dividend yield.

Manufactured Home Communities, the best-performing new REIT this year according to Salomon Brothers, comprises 41 mobile home communities with more than 12,300 residential sites. This Upreit stock was offered in late February at $25.75 per share and sold recently at $41.38 per share, a 61% increase.

Manufactured Home Communities was owned by vulture investor Sam Zell and his late partner, Robert Lurie, for about ten years before it was converted to a REIT. Zell and Lurie's heirs have raised over $35 million by selling some of their interest in the company. Analysts are impressed by the quality of its management and the high occupancy rates at the housing sites. Through simultaneous debt and equity offerings, Manufactured Home Communities has paid off most of its old debt and received fresh working capital, but its balance sheet still carries some riskier variable-rate debt that leaves it vulnerable to a rise in short-term rates.

Carr Realty is another highly regarded Upreit. It owns interests in 14 office buildings with about 3.6 million square feet of rentable space. The buildings' combined occupancy rate is a remarkable 96.9%, and the REIT has done well despite the office market's dire condition. Carr also provides management and leasing services for about nine million square feet of offices in and around Washington, D.C. Its share price has climbed from $22.875 to $27.50 over the past year, which is too high for value-conscious investors.

Kimco Realty, an industry favorite and the company that set off REIT-mania with its 1991 IPO, is a big operator of malls. Winning particular praise are topnotch management and success in buying underutilized shopping centers and improving their performance. Morgan Stanley analysts Eric Hemel and Neil Barsky have dubbed Kimco the ``all weather'' company that will prosper regardless of the economy's wanderings. Kimco's most serious weakness is a lot of variable-rate debt, which the company is looking to replace with fixed-rate borrowing. Kimco, like many of the top-rated REITs, may be getting a bit expensive for investors seeking a real bargain.

Weingarten Realty Investors and Federal Realty Investment Trust are also shopping center REITs that are among the best of their kind. Weingarten invests primarily in malls in and around Houston and a few other spots in the Southwest. The company has increased earnings steadily for years and has maintained occupancy levels of 93% or better. Its stock has languished between $32.88 and $45.25, and several analysts rate it a buy. Federal Realty concentrates on buying or upgrading older malls in Eastern states. Green Street's analysts say its stock is fully priced at around $30 a share.

REITS           PROPERTY TYPE   STOCK PRICE   12-MONTH      CURRENT
                                9/23/93       PRICE RANGE   YIELD
                                              9/23/92-93    9/23/93

Federal Realty       Malls         $29.75      $22-$30.25      5.2%
  Investment Trust
Manufactured Home    Mobile        $41.38      $27.50-$43.63   5.0%
  Communities         home parks
Nationwide Health    Nursing       $39.13      $29.63-$40.25   6.1%
  Properties          homes
Taubman Centers      Malls         $15.38      $11.25-$15.50   5.7%
Weingarten           Malls         $44.25      $32.88-$45.25   4.9%
  Realty Investors

SOURCE: Fortune

PHOTO: Taubman Centers owns interests in America's snazziest malls. This one is in Short Hills, New Jersey. (GABE PALACIO)

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By Richard D. Hylton

Reported by Ani Hadjian