Make sense of this.

Los Angeles County's second quarter commercial vacancy rate hit 14.8 percent the second worst on record. And clear across the country in Manhattan just three large office buildings sold in the first half of the year a stunningly small number.

Yet investors have been flooding billions of dollars into real estate investment trusts, which are public companies that invest in offices, warehouses and other commercial real estate. REIT stocks, which hit an 18-year low in March, have rallied in the past five months, with the average local REIT up 92 percent.
Clearly, the thinking is the worst of it may be over, or is nearly so, and buying opportunities abound.

Already this month, two local REITs HCP Inc. and PS Business Parks Inc. have successfully completed new equity offerings that netted a combined $594 million.

What's more, a number of new REITs are entering the fray.

To name two: Colony Capital LLC, the Century City investment firm, filed a prospectus June 30 to form a public REIT subsidiary, and Western Asset Mortgage Capital Corp. in Pasadena filed an IPO prospectus June 12.

"Many REITs have been raising equity, reducing debt and shoring up the balance sheet," said Jerry Doctrow, a stock analyst with St. Louis-based Stifel Nicolaus & Co. Inc. "People have been attracted to REITs anticipating that they will be able to make opportunistic investments going forward."

That's not to say that the entire REIT industry is healthy. Indeed, those with heavy debt loads, such as General Growth Properties Inc. in Chicago and Maguire Properties Inc. in downtown Los Angeles, have been decimated in this recession.

But in the bigger picture, investors believe most REITs will survive what has been perhaps the biggest downturn in commercial real estate since the Great Depression. And the bottom may be coming faster than anyone could have imagined just months ago, giving the REITs potentially unprecedented pickings of distressed debt and cheap real estate.

The Massachusetts Institute of Technology's Center for Real Estate issued a report this month that found commercial real estate values fell 18.1 percent nationwide in the second quarter, the biggest decline in the 25 years the index has been published. Moreover, the index's 39 percent decline since its peak in the middle of 2007 is far greater than the 27 percent decline the index experienced during the real estate bust of the early 1990s.

"(REITs) see opportunities out there that they can take advantage of if they have capital," said Nick Einhorn, an analyst with Renaissance Capital, an IPO tracking firm in Greenwich, Conn., who says there are at least 18 REIT IPOs in the pipeline nationwide.

Debt and opportunities

REITs, which are exempt from corporate income taxes so long as they pay at least 90 percent of taxable income to shareholders, had gained favor with investors over the past two decades for their high dividends.

But as the commercial real estate market began to turn south last year, investors grew uneasy about the ability of REITs to survive amid rising vacancy rates, falling property values and maturing debt. Those with the highest debt levels were hit the hardest.

Maguire, which owns several trophy buildings downtown, including the U.S. Bank Tower, defaulted this month on seven properties in Orange and Los Angeles counties. It has been burdened by a 94 percent debt-to-capital ratio stemming from its purchase at the height of the real estate boom of a portfolio of office properties in Orange County, where the subprime industry was once booming.

And General Growth Properties, which owns the Glendale Galleria and is the second largest mall owner in the country, has been hit hard by a combination of falling property values and slow retail sales. It filed for Chapter 11 in April citing $27 billion in debt.

However, the weakness of some REITs has provided an opportunity for stronger ones.

This month, HCP announced that it had purchased at a discount of $590 million some $720 million of the first mortgage debt of HCR ManorCare, a struggling Toledo, Ohio, operator of skilled nursing homes and assisted living facilities. HCP, based in Long Beach, is the largest health care REIT in the country with a portfolio of 692 nursing homes, hospitals, medical offices and other properties.

To help finance the investment, HCP sold $441 million in new stock this month. Investors gobbled up the offering, which was expanded from 11.5 million shares to 17.8 million shares by the time it closed Aug. 10.

If the ManorCare debt matures in 2013, as expected, HCP would net more than 20 percent on its investment. If ManorCare cannot service its debt, then HCP could foreclose on ManorCare's properties and lease them back to ManorCare. In that case, the investment could yield HCP returns in excess of 65 percent, said Doctrow of Stifel Nicolaus.

"HCP is one of the few REITs that has started playing offense, if you will," he said.

Robert Mains, an analyst with Birmingham, Ala.-based Morgan Keegan & Co. Inc., praised HCP's move and suggested there may be more opportunistic acquisitions to come.

"Despite being (one of) the largest health care REITs, we expect it to be one of the fastest-growing," he wrote last week in a client note.

Shares of HCP are up 81 percent since early March. HCP did not return calls requesting comment.

PS Business Parks in Glendale recently announced the completion of an equity offering that netted it $154 million. Though executives did not announce a reason for the offering, analysts believe the conservatively financed REIT is angling to buy distressed assets. PS has an office and industrial portfolio spanning 19.6 million square feet..

'Opportunities emerge'

"They haven't identified to the market any need for that capital. I have to imagine because they came to market they are seeing opportunities emerge and they want to be able to take advantage of those," said Dave Rodgers, an analyst with New York-based RBC Capital Markets.

After their IPOs, Colony Financial intends to snag commercial real estate debt on the cheap, while Western Asset said it will invest in residential mortgage-backed securities.

But the enthusiasm for REIT stocks has not been uniform.

PennyMac Mortgage Investment Trust, a REIT in Calabasas started by former Countrywide executives, recently went public for the express purpose of buying up distressed residential mortgages. PennyMac's IPO, which netted $335 million, took in less than anticipated. And its stock, which was priced at $20 for the July 31 IPO, closed at $19.44 on Aug. 20.

Still, Einhorn of Renaissance Capital said it is likely not a significant sign for the REIT industry as a whole. He noted that there have been four successful REIT IPOs thus far in 2009. The largest was Starwood Property Trust, which this month raised $810 million, 62 percent more than anticipated. The Greenwich, Conn., REIT plans to invest in commercial mortgage backed securities.

"I don't know if you can look too much into one specific REIT," he said, adding that investors "look on a deal-specific basis."

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