Flush REITs Ride the Boom

The question is how long the good times will last in a period of rising interest rates and a national real estate market that shows some signs of being overinflated.

What's driving the incredible returns to investors, according to real estate analysts, executives and advisers, are some of the same forces that are making the prices of homes in the Washington area skyrocket. Just as low interest rates and skepticism of stocks are driving home buyers to pay high prices, investors have been bidding up the price of REITs.

But share prices have risen in many cases more quickly than operating earnings. The big question for REIT executives is how long they'll be able to keep up.

Consider Corporate Office Properties Trust. Its returns over the last five years made it one of the best-performing REITs in the industry, according to trade groups and analysts.

The company's funds from operation per share, a common measure of REITs' operating performance, rose a healthy 35 percent between 2001 and 2004. But its share price in that span rose 147 percent. That disconnect, between underlying operations and the company's stock price, makes some analysts think the REIT sector will be hard-pressed to continue its gains.

Indeed, there are hints that the market is already readjusting. REITs have a total return of minus 6 percent so far in 2005.

"The valuations might be starting to catch up with some of these companies," said Keven Lindemann, director of the real estate group at SNL Financial. "The REIT market has been well above a sustainable level of returns since 2000. It's inevitable that we have a bit of a pullback."

Other local REITs have situations more unique to them. CarrAmerica Realty Corp. has seen strong performance from the 23 properties it owns in downtown Washington and the suburbs. It owns several large buildings in the 1700 block of Pennsylvania Avenue and a building in Reston where Nextel Communications Inc. has its headquarters.

But analysts and executives at CarrAmerica said its performance has been dragged down by the 85 properties it owns in places like San Francisco, where the office market has lagged in occupancy and rents have fallen 50 percent or more since 2001.

"The Northern California market has lagged D.C. and Southern California," said Tom Carr, chief executive of Carr. "It's now beginning to kick in. Occupancy rates are rising slightly. We're seeing leasing activity pick up significantly and in certain sub-markets rents are beginning to move as well."

Carr netted $192 million from the sale of buildings it had in Atlanta, and sold a building it owned in suburban Austin. Both are competitive markets and have performed below the rest of the country. The company's funds from operations for last year were up slightly, to $3.09 per share.

"Carr has lagged because of its exposure to California," said Keith Pauley, managing director at LaSalle Investment Management Inc. in Baltimore. "They're in a lot of markets that are much weaker than D.C."