Special to Real Estate Weekly (1/26/00 issue)
SAVVY REITS USE SCREENING TECHNIQUES
TO ACQUIRE QUALITY PROPERTIES
By Georgia Malone
President
Georgia Malone and Co., Inc.
New York, N.Y.
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Georgia Malone, president of Georgia Malone & Co., Inc., is an attorney, broker, and real estate advisor, who is actively involved in the sale and purchase of multifamily portfolios for acquisition by REITs and other buyers.
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In the early nineties, the REIT game was quantity. Hungry REITs eager to show growth and satisfy anxious investors appeared to be on a non-stop acquisition binge of residential and commercial properties. The thinking was that the more REITs would buy, the more assets they could show, and hence higher and higher earnings. Acquiring more and more properties, it was believed, was the sure route to REIT success.
However, Wall Street took a dim view of this acquisition philosophy even though the real estate market boom was fueled in part by the REIT frenzy. Many properties that appeared on the surface to be decent purchases turned out to be poor investments. Suddenly to some analysts the balance sheets of successful REITs began to look suspect.
As the stock market turned tough on REITs, executives had to focus in on something they could control—how to run their businesses more efficiently and profitably, as well as ensuring a strong revenue stream for their stockholders. A big answer to the problem could be found in how REITs acquired properties.
To insure a better return on investment for stockholders, REITs needed to develop a better screening technique to identify potential properties, even before they did due diligence to evaluate the property’s quality and long-term asset value.
In screening properties on behalf of our REIT client, we have developed five key criteria that must be satisfied. They are: Cap rate, location, age of units, resale value and financeability of the project.
The second most important criterion is location. An acquisition director should strive to buy a mix of A, B and C type residential properties in different areas of the country as a diversification tool. The idea is not to concentrate in just one area of the country or with one particular type of property.
Here’s why: if there is a downturn in the economy in the Northeast but a boom in the Southeast, one serves to balance out the other so the REIT does not get burned.
While location plays an important role in finding quality properties, REITs should also investigate the complex’s infrastructure. REITs should not overlook the relationship between the age of a complex and its maintenance requirements as older complexes are usually more expensive to maintain.
What hurt many REITs when acquiring residential properties is that they did not pay attention to the renovation cost of older complexes. Whether it costs $500 or $20,000 to fix up a unit, it is important to know the property’s age and how the renovations will affect the bottom line, which could impinge on a REIT’s net operating income.
The days of simply acquiring and selling properties to achieve higher earnings for a REIT are now long gone. With stockholders demanding better returns on their investments, REITs must follow a specific set of guidelines in screening and identifying "quality" properties in order to survive and expand their businesses. If not, REITs will face a very difficult future in attracting capital for new investments.
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