Rising Rates Deflate REITs but Analysts See Sale-Level Prices

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Rising Rates Deflate REITs but Analysts See Sale-Level Prices

WALL STREET WEST

Real estate investment trusts, popular for providing relatively steady returns while interest rates were low, have been hit hard in the past month, with many of their stock values shedding from 10 percent to 20 percent or more.

The volatility in REITs, which use the pooled capital of investors augmented with borrowed money to purchase and manage income-producing real estate, kicked off on April 2 with a surprisingly strong employment report.

Investors, scared that economic recovery and inflation concerns would lead to higher interest rates, fled REITs and began looking for yield alternatives in fixed income markets.

“It’s been their own version of April showers,” said Chris Hartung, an analyst with W.R. Hambrecht & Co. in San Francisco.

The REITs hit the hardest in April were the ones that had performed best over the prior four-year period, primarily those in the retail sector.

Santa Monica-based Macerich Co., which had seen its stock price increase 77 percent since the beginning of 2003, was off about 20 percent in April, dropping to $43.63 on April 27.

“Macerich had done very well and was trading at a premium to the market,” said Todd Stender, an analyst with Crowell Weedon & Co. in Los Angeles. “They were more likely than others for a decline.”

REITs that fared better during the April rout tended to be in the office or industrial market, where continued vacancies had tempered stock performances, Stender said.

Los Angeles-based Arden Realty Group Inc. saw its stock fall 13 percent, to $28.70 on April 27 from $32.86 on April 1. Arden shares had increased 49 percent from the beginning of 2003 to the start of April 2004.

“The blow wasn’t as steep because they’re an office REIT,” Stender said. “They were discounted to begin with.”

But Hartung said REITs were due for a little shakeup after having outperformed the market on one-year, three-year and 10-year time frames.

For 2000 to 2003, the S & P; REIT Composite Index produced an average 12.4 percent annual return, compared with a loss of 5.3 percent for the S & P; 500.

“They were getting frothy,” Hartung said. “This is healthy in the longer term for the market. It allows more sensible valuations in the marketplace.”

REITs are required to distribute as much as 90 percent of their income as dividends, producing yields that often hover around 6 percent to 7 percent, Stender said.

The consistent returns have historically attracted long-term investors, but as interest rates remained low in 2003 going into 2004, more short-term investors jumped into the REIT market for higher yields than the stock market. The short-term investing mentality altered the traditionally stable values of REITs.

“The severity of the drop has been surprising. It has to do with the nature of the capital that has flowed into the space in the past six months,” Hartung said.

The silver lining is that many REITs are at more of a bargain price at a time when an economic recovery will produce growth in the REITs’ operating incomes.

Crowell Weedon singled out in its research report the preferred securities of Glendale-based PS Business Parks Inc., because they trade below par value of $25 and yield 7.3 percent.

But analysts say the market will be rocky in the next three to six months as news of interest rates and economic recovery continue to create some volatility.

“It’s good if you’ve got anything except for a three to six-month window for investing,” Hartung said. “Heading into the economic upturn, we will begin seeing dividend increases, accelerating into ’05.”

Karey Wutkowski

VC Rebound?

Venture capital appears to be on the rebound in Los Angeles, though appearances can be deceiving.

Startups received the largest increase in funding, up 130 percent in the first quarter, than they have in two years.

A total of $199 million was invested in 18 companies, compared with $86 million in 12 companies for the like period a year earlier, according to the quarterly venture capital report from Ernst & Young and VentureOne, a unit of Dow Jones & Co.

But the results are murky because bigger deals dominated the quarter and a few of the investments were second, third or fourth rounds of funding from backers seeking to turn around original investments.

“There’s still a lot of interest in staying focused on startups and a pipeline of startup transactions,” said Donald Williams, Ernst & Young’s venture capital group leader for the Pacific Southwest. “A lot of the financings are tied to IPOs with a mezzanine round of financings used to dress up the balance sheet before an IPO.”

A good example is HOB Entertainment, owners of House of Blues clubs and nearly a dozen amphitheaters, including Universal Amphitheater.

Ares Management, the large private equity fund in L.A., invested $35 million in HOB Entertainment, which already has the backing of J.P. Morgan Partners. The company had to be recapitalized to the tune of $110 million with a new bank credit facility from Banc of America Securities.

Other big deals in Los Angeles included 5Square Systems, of Westlake Village, a software management firm for auto dealerships. It raised $12.3 million from two Palo Alto firms, Norwest Venture Partners and Storm Ventures. MicroFabrica Inc., a manufacturing technology firm in Burbank, received $15 million in a second round of financing from WK Technology Fund of Taiwan.

Kate Berry

Acquisition Watch

City of Industry-based Global ePoint Inc. agreed to acquire the aircraft electronics and communication assets of AirWorks Inc. for $3.3 million plus an additional $3 million based on performance benchmarks, in a deal announced last week.

AirWorks’ products monitor cockpit doors on aircraft. It is the second acquisition in several weeks for the company in the area of video surveillance. Global ePoint has targeted the surveillance business as more countries adopt regulations requiring aircraft doors to be electronically monitored.

“Mandates are already out in Israel, Asia, Germany and the United Kingdom,” said Chief Executive Toresa Lou. “We expect more others to follow, like the United States.”

The acquisition will be immediately accretive to earnings this quarter, thanks to a $10 million contract the tiny company already has.

“And they continue to develop business in different areas, such as South America,” said Lou.

Three weeks ago, Global ePoint acquired Glendale-based Perpetual Digital, a privately held supplier of digital video recording systems, in another acquisition to boost its surveillance unit.

Andrew Simons

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