REITs becoming investment vehicles of choice for pension funds.

When Santa Monica-based developer MaceRich Co. held meetings with financial analysts and potential investors recently to talk about the company's initial public stock offering, representatives of pension funds were one of the groups most interested in MaceRich's new real estate investment trust.

A little more than a month after the company's stock offering, MaceRich Chief Financial Officer Tom O'Hern said, both public and private pension funds - long with other institutional investors - have bought into the MaceRich REIT.

At The Irvine Co.'s Irvine Apartment Communities Inc. REIT, which went public last December, Executive Vice President Dick Moran said approximately two-thirds of the REIT's stockholders are institutional investors, including a number of pension funds.

The pension fund's investments in the MaceRich and Irvine Co. REITs are the latest examples of a trend that, according to investment advisers, is gaining increasing momentum and could pump huge infusions of capital into REITs in the coming months.

Calpers, the California Public Employees Retirement System, has announced it plans to invest up to $250 million in REITs over the next few years. Investment advisers said other pension funds can be expected to follow Calpers' lead because the giant California fund, with $80 billion in assets, is the largest public pension fund in the country and is considered a bellwether of the industry.

"REITs are becoming the real estate investment vehicle of choice for pension funds," said Bill Chadwick, a Beverly Hills-based investment banker and investment adviser who recently formed an alliance with Big Six accounting firm Arthur Andersen & Co. to render fairness opinions on pension fund REIT transactions.

According to Chadwick, pension funds have already bought heavily into REITs and will likely invest much more in the months to come. Added Richard Klein, national director of the REIT Advisory Services Group at accounting firm Kenneth Leventhal & Co. in Century City, "There's already been heavy institutional investment in REITs, both from mutual funds and from pension funds."

The pension fund's interest in REITs has been sparked by changing conditions in the real estate markets, tax law changes that relax the restrictions on pension fund investment in REITs, and a resurgence of REITs in the last two years. Indeed, many sources said REITs have gained new respectability after the "REIT debacle of the 1970s" and a marginally successful attempt to revive them in the 1980s.

REIT s earned a bad reputation in the 1970s, sources explained, when they were mortgage REITs formed by banks and other lenders, not to own property directly, but to make construction loans. But many of those construction loans went sour after a combination of the oil crisis, a recession and rising interest rates, so many of the REITs collapsed.

In the eyes of pension funds, the collapse of the 1970s REITs is "a big part of what the (REIT) industry has to live down," according to Roger Franz, a Calpers mortgage investment officer.

Chadwick explained that those investing in REITs believe the real estate markets have, for the most part, bottomed out and that properties underlying the REIT will provide cash flow and appreciation. Many of the REITs also are being formed by established real estate development and management companies, so the pension fund managers believe the properties will be well-administered.

As of Jan. 31, Chadwick said, a study of 191 publicly held REITs showed they returned an average annual yield of 6.76 percent - better than yields on many other investments - although he said the performance of REITs in general many have suffered in recent weeks with the ups and downs of the stock market.

Chadwick said another attraction of REITs for pension funds is that REITs are a more liquid investment than owning property directly because the shares of a publicly held REIT are traded on the stock markets. Chadwick noted that pension funds generally view REITs "not as an alternative to their directly owned real estate portfolio, but as a supplement."

According to Klein, whose firm acts as an adviser to Calpers and prepared a report that led to Calper's decision to invest in REITs, liquidity is an important factor for pension funds because many of them had trouble unloading property in the late 1980s and early 1990s when it started dropping in value in the real estate downturn.

"Buying into a REIT is different from buying an asset directly or through commingled funds. As values started declining in the late 1980s, many of the investors were stuck with investments they couldn't get out of in time," Klein said.

According to Franz, Calpers views its plans to invest in REITs as a way of diversifying its real estate portfolio. He said Calpers expects REITs to eventually represent approximately 5 percent of the pension fund's real estate portfolio value, which currently stands at about $5.3 billion. Although the giant fund has no REIT investment now, Franz said, it plans to hire a real estate securities manager to make recommendations on REIT investments. Calpers hasn't decided exactly when it will buy into REITs, but "it will be sooner rather than later," Franz said.

According to Klein, much of the pension fund interest in REITs also has to do with federal tax law changes that were adopted in 1993 and took effect Jan. 1 of this year. Klein explained that the new tax law removed restrictions that had previously limited the size of the stake a pension fund could hold in a REIT.

But possibly the biggest reason pension funds believe in REITs and that so many REITs have been formed of late, Klein said, is that "REITs have changed their fundamental structure."

Following the "debacle of the 1970s," REITs surged again in the mid-1980s, Klein said, but the surge never caught on like the current wave, which began in 1991, when property owners and developers started looking for other ways of raising money to replace banks, insurance companies and other traditional sources of capital that have all but disappeared.

The difference today is that the REITs are known as "equity REITs," meaning they are formed to own property, as opposed to the earlier generations of mortgage REITs formed to lend money.

"When you buy into an equity REIT, you are buying into a company that owns property - not just a construction loan on a property that is being built or a mortgage on a property," Klein said. "This current round to REITs started after people started thinking that real estate prices seemed to have hit bottom and what whatever risks there are in owning real estate could be overcome through the structure of a publicly held REIT."

REITs can also be privately held. But it's the publicly held equity REITs that are making such a big splash today by raising billions of dollars in initial public stock offerings.

Besides offering pension funds liquidity and a means of diversifying their real estate portfolios, REITs are appealing to pension funds because today's REITs are structured to allow investors to choose the type of underlying property and geographic area they prefer.

"The REITs of today, unlike those of the 1970s, are very much focused according to geographic area and product type," Klein explained. "For example, if you wanted to buy apartments in Southern California, you could buy the Irvine Co.'s apartment REIT. If you want to buy apartments in some other part of the country, or factory outlet malls, or some other category and some other geographic area, you can do it."

Franz said he also believes REITs are a good bet because REIT management typically owns a significant portion of the REITs shares, giving management an incentive to increase the value of the properties and sell them at a profit if the time and price are right. Explained Franz: "In the past, real estate advisers have been criticized because they don't sell when it's time to sell because they have nothing (invested) in the deal except to earn fees out of it. But in a REIT, management may own from a few percent to up 60 percent of the shares. We think that's an appropriate alignment of management's interests and the shareholders' interests." Yet another appeal to REITs, he added, is that the market price of a REIT stock is listed every day on the stock exchanges, meaning investors don't have to obtain appraisals or wait for comparable sales to ascertain the value of their holdings.

Although Calpers' decision to invest in REITs is viewed as a sign that other public and private pension funds will look favorably on REIT investments, not all fund managers are wild about REITs and not all of them even agree that a REIT is a real estate investment.

Joseph Carieri, senior investment officer at the $15 billion (in assets) Los Angeles County Employees Retirement Association, said that pension fund "is not interested in REITs right now," even though the association is "bullish on real estate" and has recently hired four new investment advisers to increase its real estate holdings.

Carieri and Allan Moore, assistant general manager of the $5.7 billion (in assets) Los Angeles City Police and Fire Employees Pension Fund, both said they would consider REITs more of a stock market investment than a real estate investment. Whether they ultimately get involved in REITs will depend on how well REITs perform and on investment decisions made by their governing boards, they said.

Nonetheless, many public and private funds have already made the move into REITs and, if Calpers is any indication, bigger investments will flow into REITs from the funds.

As Franz noted, if Calpers was to invest $100 million a year in REITs for the next 10 years, the value of its REIT holdings - assuming current yields delivered by REITs - could reach $1.7 billion at the end of that time.

"If we achieve that kind of funding, REITs will play a very important role in our real estate portfolio," he said.