REAL ESTATE: FINDING BUYS IN THE RUINS Empty offices abound. Equity REITs have climbed this year, but bargains remain.
By John J. Curran REPORTER ASSOCIATE Mark M. Colodny

(FORTUNE Magazine) – In bygone years, rich returns made commercial real estate one of the sturdiest inflation hedges. Widespread overbuilding has undermined that idea. While commercial construction has slowed, office vacancy rates in major American cities still average 16.7%, vs. only 3.4% in 1980. That's not all bad. Depressed prices create opportunities for investors. The most popular route by far is the real estate investment trust. Over 100 REITs, which offer investors the easy liquidity of a publicly traded company, trade on major stock exchanges. Equity REITs, which own real estate, have lately been yielding 7.8% on average, more than double the average yield of stocks. Yields on mortgage REITs, which typically offer no profit from property appreciation, have been running at 13.3%. This year, equity REITs have made a strong showing despite the soft property market, but analysts still find a few buys. Among the most attractive are REITs that own shopping centers. Investor interest is high, so yields average only 6.8%. But some shopping center REITs have exceptional growth potential. One of the most promising, according to REIT analyst Gregory Whyte at Shearson Lehman Hutton, is Federal Realty of Bethesda, Maryland. Federal's specialty: buying existing shopping centers in the high-growth Washington-Baltimore corridor and upgrading the roster of tenants, paving the way for higher rents. The current yield is 5.9%. The contrarian's paradise is Texas, where the oil price bust has produced a cavernous 22.9% office vacancy rate in Houston. Despite that tough environment, the Houston holdings of Weingarten Realty -- mostly shopping centers -- have never fallen below 91% occupancy. Sam Lieber, who runs Evergreen Global Real Estate Equity, a mutual fund in Purchase, New York, is keen on Weingarten, which yields a comforting 5.8%. David Shulman, a real estate analyst at Salomon Brothers, is urging clients to load up on property in the Pacific Northwest, where prices are still relatively cheap and growth prospects good. No REIT offers a pure play in the region's real estate, but one way to get in, Shulman says, is through BRE Properties, with a diversified portfolio of shopping centers, apartments, offices, and industrial space in Northern California and the Northwest. It yields 7.8%. Real estate limited partnerships are out of favor lately because of high fees and poor performance. But Barry Greenfield, manager of the Fidelity Real Estate fund, thinks there's good value in some that have been bundled into master limited partnerships and now trade like stocks. Greenfield especially likes hotel partnerships that trade at steep discounts from the breakup value of their portfolios. Among his favorites are Red Lion Inns Limited Partnership, which trades at $19 per share, well below its estimated breakup value of $25 to $35 per share. He also likes Motel 6 Limited Partnership, which sells for about $18 but has a potential breakup value of $24 to $30. Of course, the partnership's management may never try to cash in on that value, but don't rule it out. Motel 6 stock is 51% owned by Kohlberg Kravis Roberts.

CHART: NOT AVAILABLE CREDIT: SOURCE: NATIONAL ASSN. OF REAL ESTATE INVESTMENT TRUSTS CAPTION: NOT LIKE THE GLORY DAYS Until 1987, average total returns on equity REITs kept investors miles ahead of inflation. Though smaller, the advantage is back.