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Local REITs May Escape an Industry Downturn

By Jerry Knight
Monday, January 10, 2005; Page E01

Real estate investment trusts were the best-performing sector of the stock market last year, producing returns of 40, 50, 60 even 70 percent for investors in the 18 REITs in the Washington area.

But that was last year.

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This year, REITs could remind investors of the maxim, "Past performance is no guarantee of future returns."

Many real estate experts predict that investors will make no money in REITs in the next 12 months. Investors will continue to collect healthy dividends -- now averaging about 5 percent -- but the payouts will be offset by declining stock prices.

Optimistic forecasts are for 10 percent returns -- half of it from dividends. Pessimists expect a widespread retreat by REITs as rising interest rates erode the industry's impressive gains of the past couple of years.

REITs are off to a lousy start. Down five of the past six trading days, the benchmark Morgan Stanley real estate index, which gained 30 percent last year, has already lost 4.9 percent in the new year.

The REIT index fell again Friday after the December employment report showed that the U.S. economy created fewer jobs than expected. Job growth was too slow to generate an economic rebound that would help the commercial real estate industry, but fast enough to encourage the Federal Reserve to keep boosting interest rates.

How fast and how far the Fed raises rates this year is the key question for the REIT industry. Last year's spectacular REIT returns were fueled by historically low interest rates, which enabled REITs to get low-cost financing for their buildings. At the same time, low rates make real estate a more attractive investment than bonds. Economists are virtually unanimous in predicting that interest rates will increase further this year.

But while rising rates bode badly for REITs -- and home-building stocks -- the dozen and a half REITs based in the region include several that ought to outperform the sector.

Three are in niches that should allow them to do better than real estate as a whole -- Mills Corp., builder of Potomac Mills and other big shopping centers; AvalonBay Communities Inc., whose upscale apartments could benefit from a rate-induced slowdown in home buying; and American Community Properties Trust, which specializes in office buildings for government agencies and defense contractors, two tenants largely exempt from the usual office-market cycles.

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