The high-tech and dot-com boom of a few years ago gave investors a taste of higher-than-normal returns, but with the way the economy is today, the stability and modest returns that real estate investment trusts (REITs) offer are extremely appealing to both individual and institutional investors.

To find out the latest on REIT activity in the Midwest, Heartland Real Estate Business discussed this and other issues with executives from several REITs: Allan Sweet, president of AMLI Residential; Thomas Peck, senior vice president-investor relations with Duke Realty Corporation; David Helfand, executive vice president–chief investment officer with Equity Office Properties; Arne Cook, managing director for First Industrial Realty Trust’s Midwest region; Richard May, chief executive officer of Great Lakes REIT; Bill Anderson, vice president – acquisitions at Inland Real Estate Corporation; and Barbara Baker, vice president of investor relations with Taubman Centers, Inc.

HREB: What is your view of the REIT market today?

Cook: Over the long haul investors reward consistent performance and that’s one of the reasons REITs have done well lately and why we [First Industrial] will continue to do well in the future. In fact, on a total return basis, the Morgan Stanley REIT Index has returned 8 percent over the past 12 months, compared to a 21 percent loss for the S&P 500. And the story only gets better when you look at the 3- and 5-year returns. The Morgan Stanley REIT index returned 48 percent and 22 percent over the past 3 and 4 years, respectively, compared to an S&P 500 loss of 36 percent and 11 percent over the same periods. So, as investors sit back and reflect over the past few years, more and more are acknowledging the benefits of owning REIT stocks in their portfolio. There are very few equity investments today that offer the kind of consistent, stable and relatively predictable returns that REITs offer through their dividend yield and share price growth, provided by “real earnings” and secured with hard assets, such as real estate.

We think the industrial REIT sector in particular has a significant growth opportunity in the U.S. There is 25 billion square feet of industrial real estate in the U.S., of which 65 percent is owned by Corporate America. As companies continue to re-deploy the cash currently locked up in their real estate back into their business and as they reconfigure their supply chain, their real estate requirements will naturally evolve and expand. This produces opportunity: property sales, sale lease-backs, development, redevelopment and leasing of existing property inventories. These trends bode well for the REIT industry. First Industrial, in particular, is well poised to seize these opportunities since we have abundant capital, we possess all the real estate expertise in-house and we invest in diverse property types and operate in markets throughout the U.S.

Sweet: REITs are being viewed more positively than tech stocks today because of the safety and stability of the underlying assets and the income stream they are from. Unfortunately, the weak economy still affects real estate, and thus, REITs too are under some pricing pressure as underlying real estate fundamentals are weakening. This is especially true of apartments, which AMLI holds.

Peck: After the collapse of the technology bubble, real estate stocks have indeed performed very well. In the last 18 months, we [Duke Realty] have seen our shareholder base at Duke grow by more than 50 percent to over 110,000 shareholders. This clearly indicates strong demand from individual investors.
I think there are multiple reasons for this, including: with interest rates so low, our 7.5 percent dividend looks very attractive (and safe); investor expectations have returned to earth, and the combination of the dividend plus potential stock price growth of REITs compares favorably with the rest of the stock market; most REITs are safer investments than Corporate America in general; and REITs were basically untouched by the accounting and corporate governance scandals that have plagued other industries.

Helfand: REITs have been outperforming the S&P 500 for the past two and a half years. They provide a relatively stable investment option in comparison to many other stocks and are ideal for the long-term investor who wants to enjoy a dividend. Dividends in the industry are now in the 6 to 7 percent range.

May: The void left by the retrenchment in telecom and technology-related businesses has hurt all real estate from an occupancy perspective. However, the transparency of REITs and the fact that we [Great Lakes] have to pay out all of our income has caused investors to flock to REITs for the stability of returns. As a group, REITs have provided 20.8 percent, 12.8 percent and 3.5 percent total returns for the years 2000, 2001 and 2002 year-to-date. The fallout from the tech wreck has also kept interest rates at 40-year lows, which has provided a safety net from the lost revenues caused by vacancies. Further good news is that we can lock in low rates for long time periods and wait for the eventual recovery to supercharge earnings.

Anderson: While the heightened interest in real estate has made the acquisition process more competitive, we [Inland] fare quite well in competitive markets. We are a known entity, and close quickly for all cash without financing contingencies on even the largest transactions. It makes us a favored buyer for sellers and brokers to deal with.

Baker: Studies have shown that the addition of REITs to a stock and bond portfolio both increases the expected return as well as decreases the risk in that portfolio. Certainly the performance of REITs this year has shown that. The stability of rental streams — particularly in those sectors such as retail where there are long-term leases — make these investments attractive to investors. And finally investors are understanding the importance of dividends as they relate to total returns on investment portfolios. REITs currently average about a 7 percent dividend. This compares very favorably to almost every alternative. For example, the 10-year treasury is currently yielding under 4 percent.

HREB: What is your current strategy?

Helfand: Our [Equity Office] investment strategy focuses on exiting non-core assets and submarkets, while building concentrations in our top markets. We seek to leverage economies of scale, as well as to take advantage of the added benefits these concentrations offer our customers.

Cook: We are always aggressively seeking out opportunities to develop and redevelop industrial properties. We have averaged 3.5 million square feet of development and redevelopment projects over the last 2 years, making us one of the largest industrial developers in the nation. At this point in time and given the current economic environment and the state of many of the industrial markets, we are not as aggressive in pursuing speculative development. We will, however, look to make selective speculative development investments in 2003 as markets dictate and prudent opportunities present themselves.
Relative to new acquisitions and dispositions, we are very active asset managers and are constantly buying and selling properties in order to best serve our customers and create value for our shareholders. Through the second quarter of 2002 we acquired $129 million of property and sold $196 million. As part of our portfolio management program, we are taking advantage of the premium prices being paid for industrial properties by prudently selling properties and reinvesting the proceeds into more strategic, higher-yielding properties.

Baker: We [Taubman] are currently in the development mode — at the pace of a new center every year or two. We are constantly looking for new sites in attractive markets around the country.
In May of this year, we acquired a 50 percent interest in Sunvalley, a four-anchor center in Concord, California, and an additional 13.2 percent interest in Arizona Mills in Phoenix. We have been active this year with respect to acquisitions and divestitures.

Sweet: We [AMLI] are doing relatively less buying or developing than in times past. On the other hand, we are selling a little more aggressively than we have in the past. It is not a very good market in which to develop, as supply already exceeds demand by a significant amount. It is not a very good time to acquire, either, as low interest rates and lots of private capital have driven up the price of apartments to levels that do not seem sustainable to us at AMLI. It is a pretty good time to sell selectively.

HREB: On the real estate front, how do you view the Midwest right now as an investment market?
Peck: The Midwest tends to be a mediocre performer most of the time. In good times, that means that certain “hot” markets perform better than the Midwest. In bad times, the Midwest tends to be more stable, which is probably what is happening today. In general, things are still fairly weak with pockets of improvement starting to materialize slowly. Additionally, our industrial markets are in better shape and will likely recover sooner than our office markets.

May: Midwest markets are far more stable from a value perspective. Well-leased properties coupled with low debt costs and lack of other investment alternatives have increased values for A-quality properties.
Anderson: The Midwest is competitive but desirable. Demand for property is up and prices reflect that, but centers with strong tenants and scheduled rent increases are still worth pursuing. So, we continue to buy. One reason why the Midwest is our region of focus is the economic diversity and relative stability the Midwest enjoys over more volatile areas of the country.

HREB: What areas of the Midwest is your company most interested in right now?

Sweet: We are currently active in Kansas City, Indianapolis and Chicago. We are not excessively interested in any city right now.

Peck: Duke’s midwestern markets currently include Minneapolis, Chicago, St. Louis, Indianapolis, and Cincinnati, Cleveland and Columbus, Ohio. We aren’t looking to expand to any new markets any time soon, but we have always said that Kansas City might make sense for us down the road.
Helfand: Our largest market in the Midwest is Chicago, but we also have a significant concentration in Minneapolis.

Cook: First Industrial has strategically selected 25 markets in which to operate and are actively seeking to acquire, develop and redevelop industrial properties in all of our core markets as well as looking selectively at opportunities in tertiary markets. We believe the Midwest is one of the best places to be and are heavily committed to growing our portfolio in several markets here in the Midwest. Specifically, in the Midwest, we are focusing our efforts on Chicago, Milwaukee, Detroit, Minneapolis, Indianapolis, Cincinnati and St. Louis.

May: Chicago, Minneapolis and Detroit.

Anderson: We are a buyer in all primary and secondary markets of the Midwest with a particular liking for the Chicago and Minneapolis metro areas. We consider other Midwest locations as well but the tenants must be strong and the real estate excellent.

HREB: Please say a few words about your company’s performance so far in 2002 as compared to last year.

Sweet: AMLI’s performance as measured by our FFO [funds from operations] is not good. In 2001 our FFO was $2.51 per share. This year it will be less. Our current first-call estimate of 2002 FFO is $2.44 per share. This falloff in earnings (as measured by FFO) is a direct consequence of a weak economy that still has strong demand for single-family homes. Speaking on a relative basis, I believe AMLI has done a very good job of managing the process through a tough economic environment.

Helfand: Equity Office continues to outperform in its top markets. In nearly every submarket where we have a concentrated portfolio, we enjoy higher occupancy than the general market. We are well positioned to take advantage of an economic recovery because of the diversity and strategic concentrations of our portfolio.

Cook: We knew going into 2002 that it was going to be a more challenging year due to the overall weakening of U.S. corporate profits and reduced capital spending. Although we recognize there will be some bumps along the road to economic recovery, we feel our company will fare relatively well. First, we believe, and statistical evidence supports, that the industrial sector is one of the least volatile REIT investment options (as compared to office, retail, hotel and residential). Second, our company’s investment strategy further reduces our portfolio volatility through diversification by property type and by geography since we invest in and own all of the industrial property types in markets across the country. Finally, our portfolio is managed by First Industrial employees who are local experts that benefit from strong relationships with the brokerage community and possess a keen knowledge of their market. This allows us to respond to local events and to more effectively manage and lease our portfolio and seize opportunities as they arise.

Our plan for the remainder of 2002 and 2003 is to focus on the fundamentals; namely, active hands-on portfolio and investment management, and providing extraordinary customer service to our tenants. In addition, First Industrial is committed to providing customer-focused solutions to Corporate America through our corporate real estate program, Integrated Industrial Solutions. As a result, we’ve enjoyed tremendous success in our investment and development activities as well with leasing our properties.

Baker: During the 6 months ending June 30, our FFO per share was up 11.6 percent compared to the first 6 months of 2001. These results illustrate the predictability and consistency of the regional mall, even in a difficult economy. Occupancy at June 30 was higher than June 30 of last year. In the second quarter, average rent was up 2 percent from last year. In summary, it has been a challenging environment, but we have been pleased with our results.

HREB: How do you see the future of REITs in general? Your company?

Cook: I am very bullish on the growth prospects for both the REIT industry and our company. First, the REIT industry has really only flourished during the past 8 to 10 years. Thus, the REIT industry is still in it infancy and has tremendous long-term growth potential. Second, REITs are recognized as an efficient way to raise and deploy capital and have recently received a great deal of attention from the investment community for consistent and stable returns. Finally, Corporate America is under constant pressure to improve efficiency and free up capital to place back to their business and represents an extraordinary untapped market potential.

We think these trends will continue offering industrial REITs in general, and First Industrial Realty Trust in particular, enormous growth potential.

Sweet: The future of REITs in general is good. The public market provides discipline and incentives that I believe are good for real estate in the long run. The same comments apply to AMLI. We are happy to be public and believe that our long term growth prospects are excellent.

Helfand: While we believe that a rebound for our sector is dependant on the economy and office job growth, we are optimistic that we will begin to see a turnaround in the latter half of 2003.


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