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Local REITs May Escape an Industry Downturn

The region also is the headquarters of five REITs that invest in hotels, a segment of the market that defies the usual relationship between REITs and interest rates. Among them are Host Marriott Corp., which delivered a 41 percent return to investors last year, and two young, fast-growing firms that were the best performers among local REITs last year -- LaSalle Hotel Properties, which returned 78 percent and Highland Hospitality Corp., which delivered 66 percent.

Most stocks are compared largely on price performance -- how much does it go up? -- but REITs are evaluated according to total return, including dividends. Regular payouts are why people buy REITs. Under federal tax laws, REITs can avoid paying taxes if they pass on most of their profits to investors. All the numbers cited here are total returns.

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Before looking at specific REITs, Washington investors need to take a global view of the industry and understand why it has done so well in the recent past and why it is not expected to do so well in the next few years.

"The thing that really drives these stock prices is the flow of funds into mutual funds" that invest in REITs, said David Loeb, a managing director and REIT analyst at Friedman, Billings, Ramsey & Co. in Arlington. Over the past few years, with bonds paying low interest and stocks falling while the real estate market boomed, investors flocked into REITs. Aging baby boomers led the charge, seeking the safety of bricks and mortar and regular income for their retirement.

Though low interest rates helped the fundamentals of investing in real estate -- property owners refinanced just like homeowners -- the flood of money into REITs pushed share prices up far faster than earnings improved.

FBR warned investors a year ago that the REITs' run would soon be over. The warning, which proved to be prescient but premature, was surprising because the firm does a lot of investment banking for REITs and is itself structured as a REIT. Last week FBR hired a team of mortgage-securities traders away from Freddie Mac, positioning itself to become a player in the buying and selling of bonds backed by mortgages on commercial and residential property.

"What makes this game end is the rise in interest rates, " Loeb said. While earnings from real estate look pretty good compared to bonds paying low rates, real estate returns become less attractive as bond rates rise.

The sensitivity of the industry to interest rates was seen last Tuesday, when the Federal Reserve's Open Market Committee released minutes of its Dec. 14 meeting , which revealed that Fed policymakers are inclined to keep raising rates. The next day REIT stocks dropped almost 4 percent.

Most sensitive to interest rates are REITs that invest in mortgages, run-of-the mill suburban business and residential properties, and office buildings.

A standout in the office sector is Corporate Office Properties Trust of Columbia, which last year earned a 45 percent return, compared with 18 percent for bigger and better-known CarrAmerica Realty Corp. of Washington.

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