Investment Perspectives -- May, 2004

Dear REIT Investor,

The market gives, and the market takes away. So it goes with the real estate investment trusts (REITs), which plunged sharply last month after having risen steadily for a remarkable 13 months in a row.

The trigger was a swift and sharp rise in interest rates, as the yield of the bellweather 10-year Treasury note rose from 3.84% at the end of March to 4.5% at the end of April. This represents a 17% rise in just a single month. More importantly, perhaps, it signifies the end of the period of easy money and low interest rates pursued by the Federal Reserve Board since 2001. It was this low interest rate environment which invited speculation by hedge funds and other highly leveraged investors to borrow billions of dollars at very low interest rates and invest in securities with high dividend (or interest) payments. In other words, many speculators in recent months bought REITs with borrowed money. This was a very lucrative endeavor as long as interest rates stayed low and REIT prices held their value. With the sharp uptick in interest rates in early April and some initial weakness in REIT prices, speculators could sense that the game was ending and they rushed for the exits by dumping REITs. Thus did normally slow-moving REITs react rather violently, undergoing a long overdue correction in a matter of weeks rather than months.

I may have oversimplified somewhat as there are undoubtedly other factors that share some responsibility for the decline in REIT prices. But there is no doubt that the main forces resulted from a rise in interest rates.

I suspect that the bulk of the selling in REITs is now behind us. Even though interest rates will probably rise further, the increase should be much more gradual than in April. REITs now sell at approximate parity with the net asset value of their underlying properties, they pay good dividends and they will be able to grow in the years ahead as inflation carries their property values and rents higher.

Bottom line, REIT prices are back to levels where they traded last November or so. As painful as it feels, we've reverted to a level that was considered comfortable just a few short months ago. The REITs in which we choose to invest continue to be solid companies with good properties, above average dividends and excellent prospects for future returns. There is thus no reason to panic, and no reason to change course.

Jeffrey L. Friedberg