[Public Relations Department handout -- REITS, a Projection by Tim Reynolds,
Portfolio Manager]
For additional information: Johanna Thornblad Stephanie Linkous
V.P. Communications Asst. V.P. Communications
(210)308-1237 (210)308-1214
REITS WILL EMERGE AS THE SMART WAY
TO OWN REAL ESTATE IN 1996
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MARCH 11, 1996
COMMENTS BY: TIM REYNOLDS
PORTFOLIO MANAGER OF THE U.S. REAL ESTATE FUND
By the time 1996 was only five business days old, more than $1.5 billion in real
estate had changed hands. This exchange was made up of only three separate
deals. Two of them involved the purchase of well over a billion dollars of real
estate by REITs (Real Estate Investment Trusts), only a very small
fraction were non-REIT related.
The founder of Templeton Funds, investment legend Sir John Templeton, recently
said, "There is one area in America that is unusually attractive, and that is
Real Estate Investment Trusts." I wholeheartedly agree with Templeton. And I'd
like to share with you an overview of what I believe 1996 and beyond will hold
for real estate, REITs and, of course, the U.S. Real Estate Fund.
High dividends, liquidity, ease of ownership and diversification are the obvious
and often quoted advantages and benefits of real estate ownership through REITs.
I also see other macro considerations that will drive their emergence in 1996.
1. ACCESS TO MORE MONEY - REITs with good management, that have
"under-promised and over- performed" with the money they have been
given, will have access to more money. Addition ally, they can create
optimal capital structures using unsecured-rated debt, mortgage debt,
lines-of-credit, preferred stock, common stock, joint ventures, etc.,
that maximize shareholder value, provide flexibility and better asset
and liability matching. REITs will have deeper pockets and cheaper
money than other real estate investors - which means a serious
advantage in real estate.
2. CAPITAL MARKET DISCIPLINE - REITs' cost of money and the properties
they acquire and develop will be linked to market rates. If the
10-year treasury is 5%, a REIT will not develop a property that will
yield 4%. Historically, that hasn't been the case with private real
estate operators and lenders, S&Ls, insurance and commercial banks,
which explains the real estate melt down of the late 80s-early 90s.
Since real estate is traditionally a privately held and illiquid
investment, real estate values had little linkage to the realities of
the capital markets. This "fantasy-land" led people to the ludicrous
notion that building a speculative office tower in, let's say,
downtown Dallas with a possible return on investment of 6% made more
sense than buying treasuries with a 7% yield. Public ownership of real
estate through REITs means real estate has to compete for capital and
puts "Economics 101" back into investment analysis.
3. " REAL" COMPANIES - REITs resemble companies in other industries
more than many people realize. Real estate is an actively managed
asset. Management continually has to make decisions on how to optimize
profitability and cash flow growth, how to market and position a
product and how to best achieve customer satisfaction. They have to
decide how much to charge and how to motivate and compensate managers,
as well as conduct market research. Creating and maintaining
competitive advantage and capital expenditures are now part of the
day-to-day management decisions. These are the business decisions and
concerns of a COMPANY, not a passively managed collection of assets.
4. ADDED FRANCHISE VALUE - REITs are companies investing in real
estate and possessing management depth, financial resources and the
organizational structure which adds value for their customers. REITs,
as public companies, can establish products, brands, identities,
innovations, nationwide market presence and reputation to serve their
customers. Real estate provides the answer to a basic human need:
space to work and live in. The form, function and demand for that
space ultimately depend on real estate customers. Amazingly, real
estate owners are just now starting to realize that market vitality is
far more complicated than location. Technology allows people to work
out of their cars, shop from their homes and live just about anywhere.
Space needs are changing and space providers will have to add value in
changing real estate markets.
5. GROWTH OPPORTUNITIES - Property markets continue to recover, so
rents (prices) and occupancy rates (volume) are rising. Any industry
which is experiencing rising prices and an increase in sales volume is
in a position to do well. REITs' cash flow will grow from the
properties they already own. But even more growth will come from the
acquisition of properties. Commercial real estate is a $3 trillion
market, of which REITs represent approximately 3%. Obviously, REITS
have a lot of room to expand. Real estate has been a highly fragmented
and localized business. Veteran investors know that the best strategy
has always been to be the local market expert and ride out the feast
or famine conditions that occur.
For reasons listed above, REITs are in a prime position to change the
localized cycle-dependent mentality. Managements that structure
companies and operate as local sharpshooters in many markets will grow
dramatically.
REITS will affect real estate ownership and profits for several
additional reasons. One is a POSSIBLE cut in the capital gains tax. A
great deal of real estate is owned by "old money": real estate
families who want to sell but won't for estate and tax reasons. Lower
capital gains taxes would release much of this real estate.
Additionally, insurance companies continue to exit the real estate
business. Aetna just sold its real estate division and others are
regularly selling properties to meet the recently raised risk-based
capital requirements. In short, motivated and willing sellers exist,
and REITs will be positioned to capture most of the quality
properties.
6. MARKET ACCEPTANCE - REITs have been around since 1960 and most of
that history is rather dismal. The 'modern' era of REITs really began
in 1993 when the number of companies and the capitalization of REITs
exploded. Quality REITs now number more than 100 and have a market
capitalization of $60 billion (about the same as a substantial oil
company). Even if my above prognostications are only partially true,
REITs should snowball and become a major sector of the financial
markets. Institutional investors would almost have to invest, since
REITs' capitalization could conceivably approach one-half trillion
dollars. REITs would, in effect, be TOO BIG TO IGNORE.
REITS ARE NOT WITHOUT SKEPTICS OR PROBLEMS. They are a different breed of
animal. Some investors consider them bond substitutes, others as small-cap
stocks or real estate. Subsequently, people buy and sell with different
objectives in mind. At times, this creates short term volatility and reduced
liquidity. Moreover, many institutional investors, particularly pension funds,
aren't sure how to classify REITs in terms of asset allocation. It is these
differences in opinion that make the markets thrive.
THE BOTTOM LINE. I maintain that REITs are stocks/companies specializing in real
estate just like GM is a company specializing in automobiles. In the short term,
REITs trade like stocks and are subject to all the vagaries of a moody market,
but in the end it's the cash flow from real estate that matters. I expect the
previously mentioned advantages to materialize in 1996, and I anticipate the
U.S. Real Estate Fund to profit.
For more information on the U.S. Real Estate Fund, including charges
and expenses, call 1-800-US-FUNDS (1-800-873-8637).
Please read the prospectus carefully before investing.
