"Too much of a good thing" is an appropriate description of the torrid IPO (initial public offering) market of the past three years. The market hit an unexpected brick wall in the latter part of 1994, leaving equity offerings, potentially worth billions of dollars, in the pipeline waiting for it to improve.

However, while the number of companies receiving real estate investment trust (REIT) status in 1995 is expected to be few, most bankers, investment analysts and REIT executives believe the strong market for secondary offerings from established REITs will return, and that the current slowdown is just a temporary pause for investors to catch their breath.

"We had a frenzy of activity in the market in 1992, 1993 and 1994 which brought 100 new REITs and more than $31 billion in capital to the industry," says Mark Decker, president and CEO of the National Association of Real Estate Investment Trusts (NAREIT), Washington, D.C.

"For almost two years there was an average of $1 billion a month in REIT stock being issued," says Richard Schoninger, managing director and head of the real estate banking group at Prudential Securities. "Supply outweighed the demand."

In fact, 1993 was a record year for IPO activity with $8.6 billion raised from stock sales. In addition, $3.4 billion was raised from secondary offerings. This glut of stock eventually outpaced investor dollars.

"There was just an oversupply of new stock hitting the market and it was tough for the investment market to digest it all," agrees Barry C. Curtis, an associate analyst with Baltimore-based Alex. Brown & Sons.

Anytime you create that many of anything in such a short period of time you are going to test the capacity of the marketplace," adds Daniel Alpert, senior vice president with New York-based Coppenheimer & Co.

So far in 1995, the secondary market has picked up for established REITs with good track records (Developers Diversified and Kimco have already successfully completed secondaries this year). However industry watchers say the number of IPOs completed this year will slow considerably for a number of reasons.

"The IPO window closed in October and has not reopened," says Chris Niehaus with New York-based Morgan Stanley. "But most mall companies that were going public have already done so. There will never be as many IPOs as there have been in the past."

"I think the demand for new IPOs had been met and the cash levels within that universe of buyers had come down a bit," says Jim Sullivan, senior real estate analyst and vice president of New York-based Prudential Securities Inc.

In addition, some early REIT investors were only interested in turning a quick profit. "A lot of the investors who bought REIT stock in the early 1990s were probably not the true long-term, real estate-oriented REIT investors," says Kevin B. Habicht, CFO with Orlando, Fla.-based Commercial Net Lease Realty Inc. "There were a number of momentum players that came into the sector because it was hot, and when it cooled off late last year they got out. As a result, there is a more stable shareholder base across all REIT sectors.

Gary M. Ralston, Commercial Net Lease Realty's chief operating officer, adds that the redistribution of REIT stockholders is a positive indicator that the industry is maturing. "It is probably a paradigm shift which occurs in many industries as they mature and change. That is one of the reasons that you have seen a shift of focus from Wall Street and some of the mutual funds."

As the tide of investor interest and cash ebbed, potential equity offerings amounting to $8 billion were left high and dry and forced to wait for another investment window which has yet to appear. Sullivan says the backlog breaks down to 80% IPOs and 20% secondary offerings.

The consensus seems to be that only companies with "unique stories" will generate the investor interest to get out of the IPO gate this year.

"Unique story means a security that offers investors an opportunity that they do not have today," says Schoninger.

Being unique could mean a portfolio of properties in a particularly strong and unrepresented market, or even an impressive management team that can be expected to successfully build a REIT. "If a potential REIT has a tight, attractive, sexy management story, it could be done this year," agrees Alpert. "One where you are buying into a company that will not come along every day."

"We refer to companies that might be interested in doing an IPO or a secondary, when the market improves as the Shadow Market," says Sullivan. Retail REIT transactions caught in the Shadow Market, that are being watched closely, include a $700 million IPO by The Richard E. Jacobs Group, Cleveland, and IPOs in the $200 million range involving Long Island, N.Y.-based Breslin Realty and Dallas-based Weitzman Property Trust. Investor interest is expected to be keen for all three firms.

Although the flood of REIT stocks on the market may have been the main catalyst of the slowdown in equity stock transactions, there were other factors involved. Low stock prices, rising interest rates in 1994, concerns about the economy and its effect on retail sales, the return of traditional lenders to the real estate market, the move of investors to other forms of investment, and the number of opportunities already existing to invest in retail real estate, all played a part.

Robert Larson, vice chairman of Bloomfield Hills, Mich.-based Taubman Centers Inc., says rising interest rates flattened REIT stock prices in the third and fourth quarters of 1994 making equity sales less attractive. "With the depressed price levels, coming out just did not seem feasible to many," he says.

The dropping REIT stock prices and concerns about the economy in general also discourage potential investors.

"The stock market has very much of a herd mentality," says Decker. "The Federal Reserve jumped interest rates seven times in a year and people don't want to be in the stock market right now. It is not an anti-REIT sentiment; it is more a fear that interest rates are going to continue to rise and the market will have to make a major correction." As a result, he says, many investors have switched from stocks to certificates of deposits (CDs), Treasury bills and money markets.

Curtis says the interest rate has had a direct impact on REITs that could concern potential investors. "To the extent that a REIT has floating debt on its balance sheet, increases in interest rates directly affect their interest expense." He adds that if REITs have any long-term debt about to mature, or if they have refinancing plans in their strategy, they may be forced into a higher interest rate environment which means higher cost of money and tighter margins.

Alpert says REITs are suffering from investors' comparisons of today's interest rate with the unnatural low rate of two years ago. "Everyone is focusing on the increases in rates from when long-bonds were at the ridiculous level in the 6s," he says. When rates did spike to 8%, that definitely hurt the industry, but rates have fallen 70 basis points since then. So the rate is pretty attractive right now.

"There is a good argument to make that REITs, particularly retail REITs, are cheap right now. I could list 10 companies that I believe are selling below asset value," he adds.

In fact, overall stock prices for a universe of 37 retail REIT stocks monitored by Sullivan dropped 2.2% this year through mid-March. Although, he points out, some of the retail REITs fared well.

"It is kind of funny that our (NAREIT) companies are reporting record earnings from their real estate and yet their stocks are still going down," says Decker. He says the reason for this is the "monolithic stock market" which has yet to take into account earnings, management and the REIT industry's healthy leverage situation. "But it will," he adds.

The reason for the popularity of REIT status in the early 1990s was access to capital. In today's improving real estate market, traditional lenders are beginning to make their way back, meaning capital need not be the sole reason to complete an IPO.

"There is more money being thrown into commercial real estate right now than at any time in the past five years," says Alpert. "There is more available cash than there is a demand for it."

Another reason for a slowdown in the industry could be that the expectation of abundant capital in the near future has taken away many companies' desire to become REITs. And, all things being equal, most executives would undoubtedly like to maintain control over their companies, rather than relinquish a portion of it to stockholders.

In addition to flooding the market with stock, the large number of new REITs already offers a wide choice of proven real estate investment options. "Institutional investors are much more willing to continue to back existing public companies that have demonstrated a history of positive earnings and a good track record, than to take a risk on investing in a new IPO," explains Schoninger.

"These new companies are just starting to distinguish themselves one from the other so buyers can tell the good ones from the bad ones. It has taken a couple of years of performance to be able to make that judgment," says Alpert.

As some companies fall behind, stronger companies will absorb them through mergers and acquisitions. "Companies that are performing well with access to capital are looking for weaker companies to acquire or merge with to create a bigger company and benefit from the operating efficiencies and synergy related to a large company," says Schoninger.

"But even well-run companies sometimes decide it makes sense to merge, says Niehaus.

"Most of the large real estate companies whose portfolios were conducive to public ownership have already made that transition." says Ralston. "As for some of the ones still in the pipeline, they may be better consolidated into existing firms." He cites the Equitable and Centermark mall portfolios which were absorbed by other companies rather than being turned into REITs.

"The rationale basically is that bigger is better in terms of market caps," says Sullivan. "There has been a correlation that bigger market cap companies are selling at higher multiples than those with smaller market caps." He adds that institutional investors have shown an inclination to choose larger companies so that the multiple will be large enough to be worth their while to invest in. He says the most common benchmark mentioned by institutional investors for market cap size is between $500 million and $1 billion.

But consolidation in the REIT industry may be more a matter of practicality than of growth. "There is clearly a for consolidation in the industry," says Habicht. "You are talking about a REIT industry of $60 billion and there are 200 public companies that are managing it. That is way too many for that amount of money."

Sullivan says the amount of merger and acquisition activity will depend on interest rates. "In an environment with higher interest rates and somewhat lower cap rates, growth through mergers and acquisitions is a more attractive avenue than raising higher interest capital to purchase individual properties or portfolios."

While some consolidation is expected, the retail REIT industry is healthy. "Most of these companies are very good," says Alpert. "They have competent management, they pick good tenants, they are very opportunistic and they are going to make money for their shareholders."

Others agree. "The recent slowdown in interest rates moving up has provided some firming of share prices," says Habicht. "So, I think the whole REIT sector has improved and has started to pick up recently."

"My assumption for 1995 is that retail REITs will see an average dividend increase of about 5% with total returns in the 13% to 14% range," says Sullivan.

"The secondary market has already picked up this year with the Developers Diversified and Kimco offerings, and I believe it will continue to accelerate through 1995," adds Schoninger.

REITs have performed well compared to other investment options. "When you look at how retail REITs performed in 1994, it is interesting that the average total return was in line with the broader equity market, in terms of the Standard Poor's 500. What is impressive and reassuring is that they performed this way in a period of rising interest rates."