After what can only be described as explosive growth in 1993, a basic rule of economics caught up with the REIT industry at the end of 1994.

"There have been no initial public offerings (IPOs) done since November," notes Devin Murphy, a principal with the New York investment banking firm of Morgan Stanley & Co. Murphy says the halt in offerings is due mostly "to an imbalance between supply and demand."

But industry insiders call this slowdown part of the natural economic cycle and hopes are high that the securitization of real estate will continue to be increasingly popular in the future, eventually capturing a proportion of the real estate world rivaling that found in countries like England and Japan.

"There have been a lot of issuers looking to tap the markets, but it's been a slowly developing market on the investor side," says Murphy, noting that "the evolution to public ownership of real estate is still in its infancy."

According to Murphy, there are currently some IPOs in registration with the Securities and Exchange Commission, so he expects to see renewed activity in 1995, although it won't reach the volume of the previous two years. (At press time, in fact, Reckson successfully completed an IPO with shares trading at $24 3/8).

Still, says Murphy, "this market can grow significantly before it even catches up to well-developed stock market exchanges around the world; in Hong Kong, real estate stocks account for approximately 40 percent of the market, they account for only about 1 percent in the United States."

Although initial public offerings have been virtually absent during the first quarter of 1995, there have been a number of secondary offerings, and Murphy says the follow-on market has been very strong. "On average, the 14 deals priced year-to-date have increased an average of 17 percent, and price pressure has been less than 1 percent negative -- I'd say that's a very healthy follow-on market."

In addition to the abundance of REIT paper on the market in 1994, the industry's performance also was affected by fluctuations in interest rates.

"When I first started looking at REITs, the story on the street was that REITs would not fluctuate as much with interest rates as they did in the past, but that turned out not to be true," explains G. Kevin Spellman, equities securities analyst with the State Teacher's Retirement System of Ohio (STERS), a pension fund with just under $30 billion in assets. Spellman notes that people who invested in REITs with an eye toward dividends exited for other types of investments when higher interest rates negatively affected their dividend yields.

David Glimcher of Ohio-based Glimcher Realty Trust, a real estate investment trust with $800 million total market capitalization, concurs. "The rise in interest rates absolutely affected REITs and private real estate," he comments. "Because of the increase, many companies were not able to make their earnings." Glimcher notes, however, that his company beat analyst projections at $2.13 per share, despite an increase of more than 300 basis points in interest rates.

According to a proxy statement, Simon Property Group Inc. (SPG), sole general partner and 60.5 percent owner of Simon Property Group, L.P., agrees that many investors look to REITs for dividend yield, stating that increases in interest rates result in better rates of dividend return on other investment types. The company professes a firm belief in the viability of long-term investment growth from REITs, resulting from attractive dividend yields and stock price appreciation gained through earnings growth of REITs.

DeBartolo Realty Corp. of Youngstown, Ohio, also witnessed the impact rising interest rates had on the industry in 1994. Though a relative newcomer as a REIT (established in April 1994), DeBartolo has been a driving force in the multi-billion dollar shopping center industry for 50 years. Its assets include 48 million sq. ft. of retail space within 28 superregional and 23 regional malls, as well as 11 community centers in 16 states.

DeBartolo CFO James R. Giuliano III says the rising interest rate environment of 1994 had several affects on the REIT industry, causing some REIT shareholders to sell in favor of other current income investment alternatives. Those REITs with floating rate debt also were affected, as well as those that were refinancing existing debt, he says.

Now that interest rates appear to be stabilizing -- and the spread between REIT yields and Treasuries has widened -- STERS' Spellman expects to see opportunities created in several real estate sectors, including hotel, office/industrial and selfstorage facilities -- sectors that now are coming into their own in the REIT universe. In years past, multifamily and retail had the lion's share of REIT portfolios.

Furthermore, Spellman expects that the entrance of more pension funds into the market also will lessen the impact of interest rate swings. "Pension funds view REITs as longer term investments," he says, adding, "Dividends are important to us, but we realize there is more to this investment than just the dividend." In addition to the 8 percent to 9 percent STERS expects to yield in dividends from its REIT investments, Spellman also expects to see real growth in funds from operation and is anticipating capital appreciation on the stocks themselves.

Of STERS' current assets, $2 billion plus is in real estate, both direct holdings and REIT investments. Of that $2 billion, $150 million plus is now in REITs, and the goal is to increase that number to between $200 million and $300 million. "Our intention is to grow our real estate portfolio by approximately $400 million a year, so that means we can grow our REIT holdings by $40 million a year once we get to allocation."

As a securities analyst at STERS, Spellman works with a staff of 40 real estate experts in making investment decisions. He says REITs can be viewed as real estate or just as regular stock. "We tend to think that REITs in the long term will act like traditional real estate; in the short term, they'll fluctuate with the market and other short-term changes like quarterly earnings, common sight management, and the various factors that can affect the performance of the stocks on a day-to-day basis."

Mark Decker, president and CEO of the National Association of Real Estate Investment Trusts (NAREIT), agrees that the numerous interest rate hikes seen during the past two years hindered the industry to some degree, because those investors looking to make money either on IPO (the "arbitrage capital") or strictly through yields left the REIT market for other vehicles. What's exciting, he says, is investors now coming to the market are there for the real estate itself. "These are long-term investors," he says.

DeBartolo's Giuliano concurs. "The more recent decline in interest rates has lowered borrowing costs, and once again increased investor interest in the REIT public market," he states.

Richard Schoninger, managing director and head of real estate banking services with Prudential Securities, also believes that the investor is changing as far as REITs are concerned. "I think what we're seeing... now ... [is] a number of long-term REIT investors ... that believe in the REIT sector," he says. Schoninger notes that the REIT industry "grew up and began to mature" in 1994, becoming a bona fide sector in the stock market. "At $45 billion, it's hard to argue that REITs aren't a real sector, especially when you consider it was only $5 billion in 1991."

INSTITUTIONAL INTEREST

According to Spellman, STERS began investing in REITs in November 1993, when it was decided that its portfolio was underweighted on the West Coast and in its retail holdings. REITs were a quick way to get to an appropriate weight in these areas, Spellman says.

When REITs began their explosive growth in 1991, it was anticipated that pension funds would be major players in the market, bringing vast amounts of capital with them. Yet, their entrance has been somewhat slower than expected, despite legislation passed in the Budget Reconciliation Bill of 1993 that removed obstacles to investing in REITs by U.S. pension funds.

Before the change in what is known as the "five or fewer rule," pension funds were treated as one investor even though they were investing funds on behalf of hundreds of thousands of people. Many in the industry say the slowness of pension fund involvement in REITs has been affected more by the nature of the funds themselves and the size of the market, rather than any congressional limitations.

"Pension funds are large entities, and it just takes a long time for them to make asset allocations," says Devin Murphy. Others say that pension funds have been waiting for the industry to become big enough to absorb large investment sums.

With a typical REIT size being $150 million to $200 million, and an internal cap on ownership at 10 percent, investments have been in the $15 million to $20 million range. This investment range doesn't excite a lot of pension funds, according to Mark Brumbaugh, a partner in the REIT Advisory Services of Coopers & Lybrand, LLP., particularly because such a size could depress the selling price on that large a share. However, Brumbaugh notes some REITs are now getting large enough to start attracting pension funds. "You're not going to see the frantic pace that occurred in 1992 and 1993," he says, "but there is a solid core of interest in REITs and they will continue to grow."

David Glimcher of Glimcher Realty Trust indicates that his company has seen substantial pension fund interest, having completed its "crown jewel" center -- The Mall at Fairfield Commons in Beavercreek/Dayton, Ohio -- in conjunction with several pension funds. "From the public market standpoint, pension fund investments have created more liquidity in the marketplace," he says. "On a project basis, pension funds provide significant equity which has aided in the development of projects for us."

A considerable amount of pension fund interest also has been felt by SPG. According to the company, as of March 31, 1995, approximately 50 percent of SPG's outstanding common stock was owned by institutional investors. At SPG, pension funds are viewed as long-term and stable investors, possessing a solid framework of understanding in retail real estate as a result of many years of direct real estate ownership.

DeBartolo has had a long history of successful relationships with outside financing partners, as well, says Giuliano. In fact, since the company became a public REIT in April 1994, its shareholder base has included a number of large pension funds. "Since DeBartolo is one of the largest publicly tradable REITs," says Giuliano, "pension fund investors have the ability to invest in DeBartolo's diversified mall portfolio and still have liquidity, a high level of current income and attractive valuations."

According to Coopers & Lybrand's Brumbaugh, there may be one other reason that REITs have not attracted as much pension fund interest as the industry had hoped during the past two years. "Many real estate people in pension funds look at REITs as stocks, and the stock advisory people look at it as real estate, so sometimes it just falls between the cracks," he says. "I think as the REITs grow bigger ... there will be more and more pension funds coming into public REITs."

The growth in the market did help to attract the Public Employees Retirement System of Ohio (PERS), which has been involved with REITs since 1990, but began investing in earnest in 1994.

"We felt the market was starting to gain some size such that large investors like ourselves could participate in a meaningful way," says Tim Getz, PERS' assistant investment officer for real estate. "One of our goals here is to anticipate market trends and get ahead of the curve; we had the sense there was going to be growing interest among pension funds in the future, and when they do get involved, the chances are there won't be enough REITs to buy."

REITs have in fact started to gain size, according to Mark Decker, who says it's a matter of educating the investing public and the real estate advisors on the advantages of REITs.

"Most pension funds do have internal policies preventing them from owning more than 10 percent of a particular company, but the average size of a REIT today is over $799 million -- there are 20 REITs that could easily take a $70 million investment, and that's a pretty good size investment by anyone's standards," says Decker. He also notes that some of the hesitation on the part of pension funds may be due to intermediaries and consultants who are not fully up to speed on the value of REITs.

"It's an excruciatingly slow process," he says. "Pension funds, for the most part, are not leaders in the investment field ... the consultants who help them have never lost a client by telling them not to invest somewhere, so they're not highly motivated to plow new ground." But, on the other hand, Decker notes that several leading advisers are now in the process of gearing up to manage REIT portfolios, and that is a very positive sign for the industry.

PERS' Getz says there is a huge convenience factor for pension funds when it comes to investing in REITs, not only because of the liquidity but also because it is far easier to manage a REIT portfolio than direct investments.

Kevin Spellman of STERS feels the same way: "It just makes life a lot easier for me because it takes a lot less time -- it's easier to analyze a company than it is to analyze a direct real estate investment."

Virtually all of the REITs in existence today have in-house management services, which gives them control over their day-to-day operations, and keeps the bottom line clearly in focus. Investors and their advisors are able to analyze the performance of a particular REIT much more effectively and efficiently -- and because these are public companies -- all the information is readily available.

This is a contrast to the REITs of 30 years ago, which were prohibited by law from having in-house management components. This was changed with the 1986 tax bill, and as a result most of today's newer REITs are established real estate firms with expertise in not only owning and developing real estate but also in property management.

There's another key difference between today's REITs and those established after Congress created the REIT vehicle during the Eisenhower Administration; that is, most of the early REITs were highly leveraged, acquisition and development lenders, rather than low-leveraged property-owning REITs like those of today.

The changes in REITs over the past 30 years have been especially attractive to institutional investors. Institutions prefer investing in self-managed companies vs. companies run by outside advisers. To become more attractive to institutions, CRIIMI MAE, a mortgage REIT, recently put forth a proposal to its shareholders to become a self-managed REIT. Under the merger proposal, CRIIMI MAE would bring inhouse all of the mortgage advisory, servicing and related businesses currently performed on its behalf by its adviser, which is an affiliate of CRI, a Rockville, Md.-based, privately owned real estate investment firm.

According to a proxy statement, self-management is intended to improve acceptance of CRIIMI MAE's stock and provide greater access to the capital markets. The mortgage REIT has an $858 million portfolio of government-insured mortgage investments. CRI is the largest owner of multifamily housing in the United States. At press time, the vote on the merger was scheduled to occur at a June 21 shareholders meeting, with the merger due to take place by the end of June.

PROPERTY BY PROPERTY TRENDS

Multifamily and retail appear to remain the darlings of the REIT industry, although other sectors also are catching fire. Most notably popular are hotels, office/industrial and self-storage facilities, which have gained strength of late and appear to be well-positioned for the coming year.

According to Decker, shopping centers and apartments will continue to be hot areas, even though they have taken a backseat in the past few quarters to sectors that are not as well-represented. "Looking at multifamily, we had two dedicated apartment REITs prior to 1991; today there are 35. In retail, we now have 11 REITs owning enclosed malls and seven owning factory outlets." He notes, also, that there is still a learning curve for many real estate analysts, and as this infrastructure develops, the quality companies are going to rise to the top no matter what sector they're in. "All the sectors will see a tremendous amount of growth," he says.

Gary Ralston, chief operating officer of Commercial Net Lease Realty, which specializes in freestanding net lease retail properties in 25 states, says it is now possible for an investor to select a company with expertise and specialization in a variety of property types. This is due to the fact that there are a number of different companies in the REIT universe from which to choose -- all of which focus on different property types, says Ralston.

Indeed, the last several years have seen a growing diversity of REITs, both by property type and by geographical area. Ralston says this new breed of REITs, in addition to the expansion in property types and geographical diversity, should increase the interest in REIT investment by pension funds and other institutions.

"Pension funds are well-suited to [become] major REIT investors in the future," he says, "not only because of the liquidity they offer, but also because of the economies of scale that a REIT is able to assemble."

Commercial Net Lease Realty's largest stockholder, in fact, is a pension fund. "Our property type is especially well-suited for pension fund investment because of the stability of income and the predictability of growth," Ralston says. "We have found that long-term leases -- that is, leases of a duration of 10 years or more -- allow for the bridging of traditional real estate cycles, and we enhance that predictability using a net lease structure." He adds that "when you combine the long-term lease with a triple-net ownership structure, you have a long-term predictable income stream that is extremely attractive to pension funds."

Dick Kadish, president and CEO of Capital Apartment Properties Inc. (CAPREIT), which became a REIT in 1992, says pension fund interest also has been strong for multifamily REITs, especially in the development of new multifamily housing.

"I think pension funds have seen that the formerly private company's expertise in this field has now been transformed into REITs, and [previous] relationships ... are once again being relied upon," says Kadish. "You're seeing some pension funds and life insurance firms coming into the fold as far as building new product." Although there has not been as much interest for existing product, Kadish says he's starting to see some movement in that area, too, particularly where there are large portfolios being acquired by a REIT.

Although other sectors are gaining strength, Kadish still sees multifamily as being the strongest right now. "Multifamily has been the bastion -- the safety valve -- the one that can be relied upon [to] get your investment return -- that's true in real estate in general."

Alan Sweet, president of AMLI Realty Co., takes a somewhat more cautious view. "There are a lot of apartment REITs," he notes. "At some point you have simply satisfied the marketplace's demand." According to Sweet, the appetite remains for office and industrial REITs and even some hotel REITs, where there has not been as much supply and the lure of an attractive investment still exists.

According to Brumbaugh of Coopers & Lybrand, multifamily and even retail may have cooled off during the last several quarters because the supply of good product has been getting tighter and the market has grown even more competitive. The shopping center REITs have been very acquisitive in the last year, Brumbaugh continues, with storage facility REITs currently growing by leaps and bounds. Manufactured homes and trailer parks, which saw significant growth in 1993, did not do as well in 1994, also because of a lack of quality product to acquire, he says.

David Glimcher says his company will "maintain its tri-focused approach, which has served to differentiate it from others in the industry." Accord-ing to Glimcher, if one sector is down (i.e. enclosed regional malls, community shopping centers or single tenant properties), there still remains two areas in which the company can continue to grow and develop.

"Currently in the pipeline, we have more than 460,000 sq. ft. of new development (in progress), which is anticipated to be completed by the end of 1996," Glimcher continues. "Additionally, we have plans for two community shopping centers/power centers -- 1 million sq. ft. -- that we expect to open by the end of 1996. There are also plans for two enclosed regional malls, one of which is expected to open in 1997."

Even with the industry's ups and downs, most insiders remain bullish on the future of REITs -- across the board in all property types. Says Prudential's Schoninger: "REITs are here to stay, and they are going to grow. I think there is great hope that pension funds will see REITs as a way to diversify their holdings. There's already more action than there was a year ago; it's a gradual type of thing as opposed to a firestorm or a tidalwave, but there is [much] hope in the REIT industry that pension funds will continue -- with great speed -- to improve their positions in REITs." This involvement, he says, is critical if the REIT market is going to reach the next level -- the $100 billion mark in capitalization -- a goal the industry seems well on its way to reaching.