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Two sides of the same street?

Opinions vary on the advantages of private vs. public REITs. You don't hear much about them, and they can be hard to ferret out. But that's just the way it is with private REITs. That's also the way many of them like it.

Although private REITs share much in common with their public brethren, there are differences that, depending on whom you talk to, present distinct advantages or real drawbacks.

Common characteristics In several respects, private and public REITs have a lot in common. For one thing, they have broadened the universe of real estate investors to extend beyond the privileged few, notes Patrick Hickey, REIT analyst with The Robinson-Humphrey Co. in Atlanta.

"Prior to REITs, real estate investment was essentially the province of the wealthy, people who had large amounts of capital," Hickey says. "Investing in real estate historically required putting up a large amount of capital for a down payment on a single property. Beyond that, it required taking on long-term debt, typically secured by the property."

Because of its single-property focus, this method of real estate investment didn't provide the benefits of diversification. On the other hand, Hickey notes, both public and private REITs "represent fractional shares of ownership, or stakes, in multiple properties, allowing market risk to be diversified."

Both private and public REITs take care of that and more. They are attractive to investors for a number of reasons. "One of the most attractive aspects of REITs is that there are no corporate income taxes," notes Scott Schroeder, corporate marketing director for Cleveland, Ohio-based Developers Diversified Realty Corp. (NYSE:DDR). A public shopping center REIT, DDR maintains a 206-property/47.7 million sq. ft. portfolio in 40 states.

"A REIT is merely an IRS election," observes Michael Klump, president of Fort Wayne, Ind.-based Equity Investment Group, "and it is the structure that was mandated by our investors for tax reasons." Equity Investment is a private REIT with a 110-property, 14 million sq. ft. portfolio of grocery-anchored strip centers in 30 eastern states.

The nation's REIT laws were the result of a lobbying effort in the early 1960s that pushed for group ownership of real estate to be taxed in the same fashion as mutual funds, according to David L. Tripp, director of investor relations and corporate communications for Columbia, Md.-based The Rouse Co. (NYSE:RSE), a public regional mall REIT with more than 250 properties in 22 states.

Prior to this time, companies that held multiple properties paid corporate income taxes on the earnings generated by the real estate, while shareholders also got hit with a tax bill for their share of the total take. Wishing to be treated in the same fashion as mutual funds, which are not taxed at the corporate level, the real estate industry was able to get legislation passed "where if you agglomerated a number of real estate projects, as long as you distributed 95% of the earnings to shareholders, the REIT would not have to pay corporate taxes," explains Tripp.

Both public and private REITs also utilize an ownership structure that makes it more tax-efficient to buy and sell properties, adds Tripp.

"A lot of shopping centers that come on the market are owned by smaller entities, such as partnerships," says Tripp. "And in many cases, the best way for these owners to sell out is to trade partnership units in a like-kind, 1031 exchange, where the seller has no tax consequences."

Less scrutiny for private REITs One advantage of private REITs is that there are fewer constituencies to answer to, whereas public REITs must inform a variety of "publics," including governmental regulators, of their activities. Equity Investment Group, for example, doesn't answer to thousands of shareholders, just three institutional partners: The Government of Singapore Investment Corp., Northwestern Mutual Life, and Carlyle Group, a Washington, D.C.-based money management firm. Additionally, says Klump, "We don't have to do all the tremendous amount of Securities and Exchange Commission paperwork that goes with being public."

At the same time, there is an upside to public scrutiny, according to Don Wood, senior vice president and COO of Rockville, Md.-based Federal Realty Investment Trust (NYSE:FRT), a public REIT with more than 120 shopping centers in major U.S. markets.

"Being a public REIT can lend credibility when dealing with various types of constituencies," says Wood. For example, one of Federal Realty's business lines involves working closely with municipalities as they recreate/restore downtown central business districts. "It is a lot easier to do this as a public company when city officials can look at public financial statements over time and feel comfortable that all significant information about the REIT has been disclosed," Wood says.

Making money Another advantage of public REITs is their ability to access public capital markets for equity dollars, says Scott G. Onufrey, director of investor relations for Kimco Realty Corp. (NYSE:KIM). A public REIT based in New Hyde Park, N.Y., Kimco has a neighborhood and community shopping center portfolio of 471 properties/62 million sq. ft. in 40 states.

When the public markets for REITs shut down in late 1998, that advantage briefly disappeared, Onufrey notes. "But obviously, when you have access to the public capital markets, it avails you of the ability to use them to continue to grow through acquisitions and development - a primary advantage over being a private company."

But on the flip side, not having to sell shares in the public marketplace has its own advantages. That luxury allows private REITs to make better use of leverage in boosting returns to their shareholders. "When the public markets are robust, they are great places to issue accretive equity for yourself," says Klump. "But for the past two years or so, most REITs haven't been able to issue any equity.

"As a private REIT, we have the flexibility to operate at a little higher debt level than our counterparts," Klump continues. "We have a conservative balance sheet, at 55% leverage. This is conservative for a private company but would be considered aggressive for a public one."

A less volatile investment? Some argue that private REITs have less market volatility than their public counterparts. "Being a private company enables us to not be subject to the whims of industry-sector issues," notes Patrick Donahue, executive vice president of asset management for Newport Beach, Calif.-based Donahue Schriber. A private REIT, Donahue Schriber maintains a 14 million sq. ft. management and development portfolio of shopping centers in the western United States.

"A sector can fall out of favor and a stock can get battered even though the company is solid and well run," explains Donahue. "Also, being a private company allows us to think on a longer-term basis, not a quarterly basis, which seems to complement the real estate industry."

Sam Lieber, senior portfolio manager and CEO of New York-based Alpine Management and Research, which runs three real estate mutual funds, says that publicly owned real estate is definitely subject to the whims of the equity market. "These stocks trade based on the market's sentiment, without necessarily having anything to do with the value of the underlying real estate," he notes.

It's a scenario that has been especially evident in the past two years, according to Lieber. "The market has been so enamored of opportunities in the Internet and high-tech world that it basically hasn't paid heed to opportunities elsewhere," including those offered by REIT stocks, he says. Other market factors, such as selling stock for tax purposes or portfolio managers "window dressing" prior to issuing performance reports, can also influence the price of publicly traded REITs. These factors affecting REIT stock valuation can cut both ways, though. "The public REITs can also trade at premiums when the market is positive, making it easier for them to raise capital," notes Lieber.

Closing notes In the final analysis, Hickey says, "there are advantages to both public and private REITs - and these can change with the ebbs and flows of the capital markets."

Successful private REITs, like all thriving businesses, keep their eyes open for new opportunities. "There are no plans on the horizon for Donahue Schriber to become a public company in the next three to five years. However, we are pursuing and investigating a number of merger and alliance opportunities," notes company chairman Dan Donahue.

And by the way, "mergers and alliances" in this market don't necessarily translate into public REITs swallowing private ones. Indeed, in a deal slated to close in third quarter 2000, Northbrook, Ill.-based Bradley Real Estate Inc. (NYSE:BTR) announced that it will merge into Boston-based Heritage Investment Trust Inc., a private REIT.

For Donahue Schriber, "some of those (merger and alliance opportunities) may lead to some sort of public event," Donahue says, a statement that may well hold true for a lot of other private REITs. But in the meantime, he adds, "we are in a very good position as a private company, and it is our intention to stay that way for at least the near term."

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