REITs build on their success
Even after outperforming stocks for five straight years, real estate trusts still offer generous returns.

(FORTUNE Magazine) – Prudence demands that analysts who cover real estate investment trusts, or REITs, be subdued in their public forecasts this year. Traditionally viewed as alternatives to bonds, high-yielding REITs (which pay out at least 90% of income as dividends) have handily outperformed regular stocks for five straight years. Which is why most experts are predicting sober, single-digit returns for the sector in 2005. Then there's BB&T's Stephanie Krewson. "I'm still a raging bull about REITs," she says.

Krewson's outlying enthusiasm is nothing new. Last year, with most analysts forecasting modest gains for the group, she predicted a 28% return (it was actually 31%). This year Krewson sees an 18% gain. And her logic is simple. Since equity REITs went mainstream with listings on the S&P 500 in 2001, they've been increasingly sought after by a broad range of investors craving income. "There was an unleashing of pent-up demand for the value that REITs represent," Krewson says, pointing to an aging generation of baby-boomers that continues to seek low-risk growth. "We are still going through this initial discovery."

Krewson's peers, however, worry that many of these new investors may start pulling out to take profits, and they point to evidence that REIT holders have become more focused on the short term. The Morgan Stanley REIT index saw a 1% price swing 79 times in 2004--twice as often as the S&P 500 and nearly five times as often as in 1996, according to J.P. Morgan's Michael Mueller. But even Krewson's cautious colleagues agree that there are still hidden values in the sector. We asked analysts for REITs with untapped value and came up with a pair of fast-growing niche players.

While Federal Realty Investment Trust (FRT, $52) is known for redeveloping high-end retail shops in tony neighborhoods, Wachovia analyst Jeffrey Donnelly says its unrecognized potential lies in its plan to develop an old San Jose property into condos. According to his analysis, Federal's condo plan could be worth an additional $2 a share over the next two years and nearly $5 a share by the time it is completed.

A less traditional pick, Capital Automotive REIT (CARS $33), specializes in financing auto dealerships by purchasing their property and then leasing it back to them. CARS has averaged a 32% return over the past five years. But it lagged in 2004 while fending off a lawsuit. Calculating that it currently trades at a 15% discount to the sector, J.P. Morgan's Anthony Paolone says it's a buy. It's no surprise that Krewson agrees.