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ZELL'S APARTMENT REIT IS LOOKING STURDY

When value investor James R. McGlynn decided to add a stock from the battered real estate sector to his mutual fund, he considered Richard Rainwater's Crescent Real Estate Equities (CEI). A Fort Worth native himself, McGlynn was well acquainted with Rainwater's illustrious career.

After some initial research, however, he quickly passed over the complex real estate investment trust (REIT), which includes office buildings, health-care facilities, warehouses, and resorts. "It is a whole hodgepodge," says McGlynn, who runs the UAM:TJ Core Equity Portfolio (TJCEX), which is up 22% this year. "I didn't want to go with anything that complicated in a difficult real estate environment," he says.

Instead, he opted for Equity Residential Properties Trust (EQR). This REIT is also huge and was founded by another legendary financier -- Chicago's brash Sam Zell. But EQR focuses purely on apartment buildings, which is an easy business to get your arms around, says McGlynn. He feels this sector should hold up well if economic growth slows next year, and he finds the stock's depressed price and 6.4% dividend yield attractive.

UP AND UP. Chicago-based EQR is the largest apartment REIT in the U.S., with nearly 200,000 apartment units in 35 states and a $5 billion market capitalization. On Oct. 19, it completed an acquisition of Merry Land & Investment Co. (MRY) for about $2 billion, which added nearly 35,000 units to its portfolio. In addition to growth from acquisitions, EQR has enjoyed strong internal growth both from economies of scale and rent increases. Occupancy in the quarter grew to 95.6% from 94.9%, according to Merrill Lynch.

On Nov. 10, EQR reported that third-quarter net income rose 20%, to $56.6 million, and revenue rose 67%, to $340 million. Funds from operations, which most analysts use as a measure of REIT operating performance, grew to $112.8 million from $76 million. That amounted to $1.02 per share, up from 93 cents a share a year ago -- a 9.7% gain.

EQR, which has returned an average of 13% a year for the past five years, traded above 50 through last April. But then it fell steadily along with the REIT sector, first on worries that real estate prices were peaking, then on fears of an economic slowdown and tightening capital markets. Some investors also judged that it had paid too much for Merry Land. EQR hit a 52-week low of 34 11/16 on Sept. 14. But thanks to an overall rebound in equities, EQR climbed back above 40 in October and has hovered there in recent weeks. It closed on Nov. 19 at 42 3/16.

EQR's valuation is currently in line with that of its peers, but analysts recommend it for its above-average growth and top management. Even if market conditions deteriorate, moreover, EQR should be in a better position than many REITs since it operates nationally and should be insulated from economic problems or overdevelopment in any one region.

"I'm not expecting anything to happen that will move it out of the low 40s near term," says David Sherman, a REIT analyst with Salomon Smith Barney. "But this is a great company, and 42 is a reasonable entry price for someone who wants to buy it and put it away for a long time."

CAPABLE CHIEF. Zell, EQR's chairman, also chairs Equity Office Properties (EOP) and Manufactured Home Communities (MHC), which are, respectively, the largest office and manufactured home REITs. He isn't involved in day-to-day operations but focuses on larger strategic issues. The guy who calls the shots, Douglas Crocker II, president and CEO, is highly regarded. "In our opinion, the senior management of EQR is very capable and is the primary key for the company's success," wrote A.G. Edwards analyst Gregory S. Sigmund in an Oct. 5 report.

Overbuilding is typically the downfall of the real estate business, but analysts aren't expecting a problem in the apartment sector. Growth in the number of building permits for new apartment buildings rose only 4% in the third quarter of 1998 compared with that quarter of 1997 -- the lowest growth in any quarter in two and a half years, according to a Merrill Lynch report. In the first half of the year, permits increased 18%. This slowdown in new construction "reinforces our enthusiasm about the growth prospects for most companies we cover" in the apartment REIT sector, Merrill's apartment REIT analyst Eric Hemel wrote on Nov. 5. (On Nov. 11, he reiterated a long-term buy rating on the stock.)

Apartment REITs are considered more vulnerable to economic slowdown than other real estate sectors, since leases are short compared with office and industrial leases. That means slackening demand is quickly translated into lower occupancies and an inability to raise rents. But McGlynn doesn't expect a recession next year and believes the economy would really have to stall out before renters would have to give up their apartments. Another risk: Apartment REITs suffer as homes become more affordable. But McGlynn thinks the homebuyers market is tapped out. "With interest rates this low, people that wanted to buy a house have already done so," he says.

Boom times in the real estate market seem to be over for a while. But EQR -- with its high dividend, above-average growth, and skilled management -- looks like a solid play at a reasonable price.

By Amey Stone in New York



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