The Weekend Real Estate Update at
MF Yorick's Bar, Grill, and
Real Estate Conversation Society
(Service for Members Only)

By Michael Dowd (MF Yorick)
and Jerry Scott (MF Foitdog)
and William Campbell (WGCAMP)

Boston, MA (April 7, 1997) -- It has been a pretty quiet week at Yorick's Bar, Grill, and Real Estate Conversation Society (Service for Members Only). Maybe it's because Boston was blanketed by the third worst snowstorm in its history on April Fool's Day. Maybe it's because we are all digesting a heavy first quarter 1997 meal of earnings and Annual Reports.

We were going to have a real party in the bar this month to celebrate The Fool's birthday, but that old party-pooper and Ayn Rand groupie Alan Greenspan had other ideas. Seeing inflation where no one else could, he bumped interest rates and took even more steam out of the more interest-sensitive stocks (like for example REITs).

Well, T.S. Eliot said: "April is the cruelest month." I figure Eliot said that because he was already an old fogey when he was still very young. Why else would he talk about spring "breeding lilacs out of the dead ground?" Well, the REIT market lately has been a lot like lilacs in Boston were this week -- muffled up in a blanket, half-frozen, and growing nowhere.

HOW IS THE REIT MARKET ANYWAY?
GOOD OR BAD OR SOMEWHERE IN BETWEEN?

Year to date (through 3/21/97), the 120 major REITs we track generated a pretty lackluster 3.2% total return, and a trailing 12-month return of 15.6%. Not too terrific considering that in the 12 months ending 12/31/96 they posted a nifty 36%. (We will shortly be able to calculate our total return numbers daily, using the new FoolREIT spreadsheet. You may want one when they are available.) Meanwhile, be sure you judge any year-to-date numbers through March 31 after taking ex-dividend trading into account. 42 REITs went ex-dividend between 3/21 and April Fool's Day. REIT dividends are usually double those of the S&P, so it is a major factor to consider.

Three of last year's top performers are off on a simple price basis over the last 30 days:

        3/5/97     4/4/97    Price 
                             Change
BCN     35 5/8     31 3/8     -12%
CEI     29 5/16    27 1/8      -7%
PAH     23 7/16    23          -2%

Adding accrued dividends in to get total return numbers for these stocks would help, and adjusting for the ex-dividend price hiccup would too, but even then their results would not look like last year when REITs' 36% total return blew the doors off a pretty healthy 23% for the S&P.

The big question now, frequently asked by new REIT investors is: "Is this a good time to be buying REITs?"

Well, in general, we note that most REITs are still trading above the median of their earnings multiples (which is bearish), but at the property level most office and hotel REITs are still growing at pretty healthy levels (bullish). We think REITs (except healthcare) are priced pretty well for people who will hold for two to three years. There are some investors who got into the field in December when prices were high and have gotten nervous and bailed out because of the present correction. We wish them well, but do not think REIT assets (which are not very volatile) will reward short-term investment strategists.

THE RACE FOR SANTA ANITA IS ON

Our blue-suited, silver-haired friend Bill Campbell (WGCAMP) was in the bar Friday, and as usual the whole place was spellbound listening to his stories. We never know whether he exaggerates, but with that classy southern accent we don't mind if he does. Bill slammed through the front door about 4 yesterday, hot off the plane from New York and full of gossip.

"As the gelding said, 'They're Off!'" Bill chortled, reaching for an of 18-year-old MACALLAN with a splash. "That often criticized recapitalization agreement between Colony Capital, actually Koll/Apollo/Colony (KAC), and SANTA ANITA COMPANIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SAR)") else Response.Write("(NYSE: SAR)") end if %> certainly appears to be off. After the agreement was announced in August, SAR's shares climbed from less than $14 to $27 indicating that the market felt that the value of SAR was significantly more than the Colony offer. Since Colony is a major shareholder and Tom Barracks, its CEO, is on SAR's board, SAR decided to let a few other horses enter the big race. Some of the new ponies must have some pretty hot workouts because SAR let the deadline for the Colony agreement expire without a new buyer. The KAC entry was miffed and took their $4.5 million breakup fee and headed for the barn. $4.5 million is not hay by any means but it's not what a high roller like Barracks was after either. Some would say Barracks' entry was scratched."

"Santa Anita said it is in final negotiations with a select number of potential buyers and that they do not expect KAC's withdrawal to affect shareholder value."

"MF Foitdog (Jerry Scott) says that Apollo Real Estate Advisors and KOLL REAL ESTATE GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KREG)") else Response.Write("(Nasdaq: KREG)") end if %>, two of the other bidders, are so sick of the war they are thinking of withdrawing from the bidding. Still, the remaining potential bidders look like a line up for the Triple Crown of REITdom. Not so much PUBLIC STORAGE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PSA)") else Response.Write("(NYSE: PSA)") end if %>, but Abe Gosman via MEDITRUST (MT), Sam Zell via EQUITY RESIDENTIAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EQR)") else Response.Write("(NYSE: EQR)") end if %> or MANUFACTURED HOME COMMUNITIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MHC)") else Response.Write("(NYSE: MHC)") end if %>, and Richard Rainwater of CRESCENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CEI)") else Response.Write("(NYSE: CEI)") end if %> are rumored to be the leading contenders. The paired share structure will allow some of these companies to do some really new era type transactions. You ain't seen nothing yet If Zell, Rainwater, or Gosman enter this derby. And an open stakes poker game among these shooters can't hurt Santa Anita."

"Maybe not," Foitdog replied, "but I wish I knew why the SEC is investigating Santa Anita's $38.5 million in write-offs from 'disposition of non-core assets' in 3Q '95."

NEW YORK OFFICE MARKET TAKES OFF

"Well Bill," said a fellow named Ralph with Hollywood shades and an Armani blazer. "Do you have any East Coast stories? How was New York?"

"Sure Ralph," Bill replied. "But up in Boston they call it New Yorick. Anyway, while we all worry about the high price of REITs and real estate, the fundamentals for office space sure seem to be solid in New York City. While I was recovering from the Motley Fool's April Fool's Day party at Morton's in the big Apple, Yorick flew down and we took a look at the NYC office market. We confirmed the fact that the market is doing quite well.

"The Studley Report indicates that Class A buildings in NYC and in NYC Midtown have a vacancy rate of 7.3% and 5.7% respectively. All New York buildings report a vacancy rate of 11.9%. The top 65 buildings in midtown have a vacancy rate of less than 3%.

"Midtown rental rates for Class A buildings and Class B buildings are $40.65 and $30.82, while Downtown rental rates are $30.17 and $24.31. Many firms are choosing slightly less prestigious locations but spending more money on interiors.

"It's very hard to find big blocks of space to lease or affordable, zoned land to build on in Manhattan right now, so the Class C and B space is getting bought at rates that would have been unheard of a year ago by redevelopers looking to upgrade it. Tired old 250,000 SF office buildings are being bought by private vulture investors joint-venturing with European and other money sources at the $100 per SF, under 9% cap rate range. There are also rumored to be some REITs in formation to capitalize on this potential (but risky) opportunity.

"This looks like pretty good news for our friend CRISVIN and others who bought into INVESTMENT PROPERTIES ASSOCIATES (OTC: IVPA) in the last few years. (If you'd like to know what we thought about Investment Properties Associates about a year ago, click here: Yorick Treads Timorously Back to the Big City...)

"Meanwhile, one of IVPA's Limited Partners dropped us a line to say, 'So, Class B buildings at $100 psf and less than 9% yields, what might the IPA 2,000,000 sq. ft. NYC & 2,000,000 sq. ft. Chicago portfolio be worth? Could get kinda interesting, doncha think?'

"What is driving that recovery and making all those landlords and investors so hopeful? Firms such as Bear Stearns need 1.2 million square feet, Citibank is looking for 800,000 square feet. Standard and Poor's wants 700,000 square feet. It may be impossible for them to find space in existing buildings in the city. More back office space will move to New Jersey. More marginal tenants will be forced out of the real Class A buildings and pushed down the office food chain into less prestigious space. Large tenants will finally team up with developers to build new buildings.

"The problem is that there are very few sites available for new construction and the same 5 sites are discussed over and over again. Because of the excesses of the 80s, developers are not likely to find financing for a new building without a top quality tenant signed up for a large part of the space.

"Times Square appears to be the most likely area for new development. The Durst Organization's new 48 story 1.6 million square foot building at 4 Times Square, to be named for and anchored by Conde Nast, was almost fully leased before coming out of the ground. Conde Nast took 585,000 square feet, and Skadden Arps has agreed to lease 660,000 square feet. If city permits can be obtained, 4 Times Square will be the first major office building in NYC to have a photoelectric panel incorporated into the outer wall of the building to provide lighting and signage for the building. There are 3 sites in the Times Square area that are controlled by Prudential and they are entertaining offers. They are excited about the prospect but not particularly eager to sell.

"Wall Street, the banks, the investors and the developers may figure out a way to screw up this market yet, but it won't be screwed up by building speculative office space anytime soon. So vacancy rates are headed down and rents, which have trended downward for the past several years, are now beginning to turn up again."

"Thanks Bill," Yorick said, poring him another on the house, "And if you can keep a secret, we are getting ready to offer you one of the country's most prestigious office research data bases right here at Yorick's."

"Who can I tell?' Bill asked. "You just blabbed it in front of AOL's 10 million subscribers and heaven knows how many net REITsters."

REIT TAXATION PROSPECTS FAVORABLE

One regular customer and quiet friend at Yorick's is Tony Edwards, who is general counsel to the National Association of Real Estate Investment Trusts (NAREIT), the major real estate trade association. Late last month (March 21) he announced some very good news that we don't think got nearly enough attention. He said:

"Yesterday, Reps. Clay Shaw (R-FL), Bob Matsui (D-CA) and 16 other Ways and Means Committee Members introduced H.R. 1150, the Real Estate Investment Trust Simplification Act of 1997. The Joint Committee officially scored it as only a negligible loss (i.e., essentially revenue neutral) and the Treasury Department has informally approved it. It might even be included in the Administration's general tax simplification proposals that are expected to be introduced in the next few weeks. H.R. 1150 contains most of the provisions that were in H.R. 2121 of 1995.

"How can a revenue neutral package help REITs and their investors, you ask? Two examples: First, H.R. 1150 would lower the distribution requirement to 90% (to match the mutual fund test and to lower it back to the REIT level from 1960-1976). Second, it would allow a REIT to earn a small amount of income (essentially 1% of a property's income) from impermissible services without "tainting" the underlying rents.

"NAREIT Members will receive a Legislative Bulletin detailing these changes next week. Also, next week NAREIT's web site will have the statutory language of H.R. 1150 and Mr. Shaw's extensive introductory remarks from the Congressional Record under the "Legal Issues" section.

"Again, H.R. 1150 is the result of 5 years of NAREIT's efforts and is considered a non-controversial and "good government" proposal by the tax mavens on Capitol Hill. Please don't be concerned that we are pushing the envelope on this one that would jeopardize the special REIT status."

Yorick grew up in the rough and tumble of Boston politics and he respects the fact that NAREIT, under the guidance of departing CEO Mark Decker and remaining General Counsel Tony Edwards, has not succumbed to the temptation to "push the edge of the envelope." Still, as was made clear on a NAREIT conference call kindly hosted by Donaldson Lufkin, the effect of all this legislation is to advance the cause of REITs. And as a side benefit, its non-controversial (so-far) passage through committee review suggests that Congress will continue to be kindly disposed to the industry. Yorick views that as quietly comforting and bullish.

NAREIT's new CEO, Steven A. Wechsler, has a strong legislative background as well. We hope all our NAREIT friends will continue to visit Yorick's place, but you might want to check out theirs as well. You can find out more about Mr. Steven A. Wechsler and lots about REITs at: http://www.Nareit.com

JAPANESE REAL ESTATE. LAND, REITs(?) and GOVERNMENT INTERVENTION

Yorick continued, flicking imaginary dust off the bar with an almost blue-white sparkling-clean bar rag, "It's not just a good tax climate for REITs in the U.S. My partner Jerry Scott (MF Foitdog) says it may also be about to happen in Japan."

"Their banks are as far into the industrial-strength weeds as ours were," Jerry notes. "On April Fool's Day the Japanese government announced it would buy $3.1 billion of land that is collateralizing bad loans. Encouraging securitization is one way to keep the country from wiping out more banks than is absolutely necessary."

Jerry further points out that, "Nippon Credit Bank and Hokkaido Takoshu Bank have $8.9 billion in bad loans, and most of them are real estate. It's been announced they will both have to close their overseas operations under government order. Even mighty Nomura, one of the world's largest securities houses, is under very serious investigation.

"American commercial real estate people have long known of Nomura and its real estate czar Ethan Penner's wizardry with commercial mortgage backed securities (CMBS). Penner's deal sizes are legendary (he actually trademarked the term "Mega-Deal" for its 4500 million plus commercial mortgage pools.) Penner's firm has had a commanding share of the U.S. commercial mortgage backed business, which packages and sells groups of commercial real estate loans. What will happen to the US REMIC (Real Estate Mortgage Investment Conduit) giant is an interesting question."

Yorick noted that there have been questions for some time about whether Nomura has been able to sell the high-risk (a/k/a "toxic waste") portion of its REMICs. There has been published speculation that Nomura was taking some or all of these tranches into its own account. It's possible the troubles at home might cause Nomura to change its willingness to carry that paper. Insurance companies have been actively shifting from direct real estate lending into buying shares in REMICs. If Nomura's US REMIC operation gets whacked, the results could be troubling, but far less so than they would have been two years ago when Nomura's market share of REMIC underwriting was even more dominant.

Anyway, Jerry, our most voracious researcher and reader, tells us the Wall Street Journal reported Japanese officials as saying there may well be Japanese REITs within a year.

A FEW WORDS FROM MF YORICK

Yorick broke in to add a word about Rockefeller Center, which is undergoing a dramatic renovation and redevelopment of its underground shopping mall, the Radio City Music Hall, and the general streetscape. You can get an idea of what excitement the area generates by watching NBC's Today show in the morning, the lighting of its Christmas tree, or the happy couples at its skating rink.

The previous owners were a REIT run by institutionally and academically trained managers after a sale and securitization in the mid 80s. That management had been burdened with debt that was based on assumptions that office rents in Rockefeller Center would be $80 per SF today. Those projections (in an underwriting led by Goldman) ignored many things, including the fact that Rock Center's floor-plates are antiquated. There are few windows in the handsome facades, and all-important corner offices are about non-existent because they are chock-full of load bearing columns. So the office portion of the center substantially underperformed.

At the same time, in a reversal of what is happening in much of the nation, Class A retail space is at a premium in New York. Chanel was happy in (and I think is now subleasing) space on 57th Street just off the corner of 5th at $1,000 per SF. Manhattan retail on 57th and down toward Rockefeller Center is often renting at $500 per SF.

The new management at Rock Center is actively adding value (or at least thinks it is) by bouncing the old tired tenants from the tunnels beneath Rockefeller Center and trying to create more of a high-end urban festival mall. Keying off the excitement that might be generated by NBC, the potential Disney redevelopment of Radio City Music Hall, and the other tourist attractions, some observers estimate a $1.5 billion increase in value from this area that a previous and more institutional Rock Center management group allowed to languish. Yorick draws two lessons from that. Don't over leverage -- and don't mistake academic management backgrounds for entrepreneurial drive.

There are many rumors of REITs looking to buy in New York, and there are more IPOs in the wings. Either way, there are apparently going to be a slew of new publicly traded players in the New York real estate markets. Since, as WGCAMP notes, a lot of the available building stock is Class B and C in need of major renovation, it will be more and more important in this and similar markets to have low debt, low pay-outs of dividends, lots of free cash to reinvest in fixing properties up and -- maybe most important -- really good management with plenty of recycling experience with a large equity stake alongside the investor's.

"There are a slew of other things I wanted to talk about," Yorick noted, "But it's closing time. I want to talk more about CMBOs and how they affect REIT valuations. I want to talk about REIT funds, notably Cohen & Steers. What about these "rapid offerings" Lehman and others have been doing for REITs? Has anyone thought of a way for investors to benefit from the explosion in the number of real estate securities lawyers being employed today? (No lawyer jokes, please.) How about PATRIOT AMERICAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAH)") else Response.Write("(NYSE: PAH)") end if %> buying WYNDHAM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WYN)") else Response.Write("(NYSE: WYN)") end if %>?

"Will STARWOOD LODGING's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HOT)") else Response.Write("(NYSE: HOT)") end if %> Sternicht buy Westin? Did Bollenbach smoke TRUMP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DJT)") else Response.Write("(NYSE: DJT)") end if %> and ITT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ITT)") else Response.Write("(NYSE: ITT)") end if %> in Atlantic City? Anyone want to discuss the world's largest real estate development? I warn you, it's in Manila. Why is Sam Zell buying parking garages? Will these piddly interest rate increases be enough to slow the demand for office space and hotel rooms? Will the Japanese really build a resort on the moon? Does that mean they will have to give back Hawaii? 77% of asset managers think real estate will go up in value this year. Is that a sign we should all go short?

"What is going to be the best stock for the real estate service sector: CB COMMERCIAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CBCG)") else Response.Write("(Nasdaq: CBCG)") end if %> or GRUBB & ELLIS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GBE)") else Response.Write("(NYSE: GBE)") end if %>?

"Who's right about BEACON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BCN)") else Response.Write("(NYSE: BCN)") end if %>, Jon Litt or Yorick?

"How many new services and profit centers can you imagine for an apartment landlord to take advantage of?"

But unfortunately it's closing time. Do come back next week sir and ma'am. Been a real pleasure serving you.

Respectfully,

MF Yorick

NOTE TO NEW READERS: MF Yorick's bar is down a quiet side street in a major metropolitan area. There's no big sign outside and it can be a little hard to find. Not every stock in real estate gets discussed every week at Yorick's, and not even every important development in the industry. But we want to know what real estate stocks and topics you'd talk about if you wandered into Yorick's some night. And frankly we want to know what you think.

So if you have suggestions or comments just E-mail them to MF Yorick. He's easy to find. Just click on the blue hypertext link and you'll be talking to the friendly corner bartender at MF Yorick's Bar, Grill, and Real Estate Conversation Society (Service for Members Only).

By MF Yorick and MF Foitdog and WGCAMP for The Motley Fool Real Estate Board but all the errors are the fault of MF Yorick.

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