By Phillip Britt

Gables Residential Trust Headquarters: 777 Yamato Road Suite 510 Boca Raton, FL 33431 Phone: 561-997-9700 Web site: www.gables.com Chairman and CEO: Chris Wheeler Senior Vice President and COO: Michael Hefley Ticker Symbol: GBP 52-week high: $32.81 (8/20/03) 52 week low: $21.43 (10/22/02) Core markets: Houston, Atlanta, Austin, Dallas, Tampa/Orlando, south Florida and Washington, D.C.

Gables Residential expects its monthly dividend and improving economic and demographic factors to pay off for shareholders.

Apartment REITs have been battling the triple threat of a weak economy, poor demographics and low interest rates for the past couple of years. Although all of these factors will be slow to improve, Gables Residential Trust (NYSE: GBP), one of the nation's largest apartment operators, is attempting to handle this trough in the apartment market by combining asset sales with a focus on upscale markets in high-growth areas and strong statistical modeling. In addition, Gables has generated buzz among shareholders with its decision to become one of the few publicly traded REITs to pay dividends on a monthly basis.

The 20-year-old company, which went public in 1994, develops, builds, acquires and manages luxury apartment homes, primarily in Houston, Atlanta, south Florida, Tampa, Fla., Orlando, Fla., Austin, Texas, Dallas and Washington, D.C. Gables' total holdings include management of 49,342 apartments in 179 communities, ownership of 84 communities with 23,338 stabilized apartments, and nine communities (2,338 apartments) under development or lease-up. In February, the company was added to the S&P 600 Small Cap Index. • The company's focus on upscale sub-markets seems to be paying off with investors despite the challenging residential climate, as Gables' share price has risen from just under $25 per share at the end of 2002 to just over $32 per share as of Sept. 1, 2003. The company has been paying a monthly dividend of 20 cents per share, which is as noteworthy for its frequency as its consistency.

Move to Monthly Dividends

A little over a year ago, the company shifted from quarterly to monthly dividends—a bold move considering only five out of more than 170 publicly traded REITs pay a monthly dividend. Gables is the largest company to do so and the only apartment REIT to make this move, according to NAREIT. The other companies paying a monthly dividend are AmREIT (AMEX: AMY), Great Lakes REIT (NYSE: GL), Realty Income Corporation (NYSE: O) and U.S. Restaurant Properties (NYSE: USV).

Gables State Thomas Townhomes, Dallas

Gables Montclair, Decatur, Ga.

"Our rents come in monthly so a monthly dividend is better aligned with the cash flow needs of our investors and enhances total returns," Chairman and Chief Executive Officer Chris Wheeler says. "Most of our shareholders are retail investors who pay their mortgages and other expenses every month. I don't know anyone who pays their mortgage and other bills on a quarterly basis. This [the monthly dividend] helps reduce the volatility in the stock price."

Wheeler adds that he expects the monthly payout should continue to draw more retail investors to the stock, increasing the share price and overall return to shareholders. In addition, he expects other REITs to follow suit and move to monthly dividends.

"Most of our shareholders are retail investors who pay their mortgages and other expenses every month. I don't know anyone who pays their mortgage and other bills on a quarterly basis." —Chris Wheeler

Although the company could not directly link any change in share price to the conversion to paying monthly dividends, Gables Chief Financial Officer Marvin Banks says the company's total return is the highest in the sector on a year-to-date basis.

While some analysts cite Gables' stock appreciation in the last year as a good performance in the face of a down cycle in the apartment industry, others question the ongoing safety of the company's dividend.

"A very strong investment market has allowed companies to sell properties and use the proceeds for dividends, but the investment market won't be strong indefinitely," says David Harris, analyst for Lehman Brothers. "When the investment market is strong, it's a good strategy for companies, but for the long term, it's not a good position to be in."

Andrew Rosivach, senior research analyst with US Bancorp Piper Jaffray, says that the asset sales don't always keep up with the dividend payouts. Therefore, he and Harris question if Gables can maintain its current payout rate.

"The dividend isn't in great shape," Rosivach says.

However, Wheeler points out that asset sales are part and parcel of Gables Residential's long-term strategy. The company sold $150 million in property in the last year and more than $400 million in the last five years. He says those analysts who look only at operating income aren't seeing the whole picture.

Rod Petrik, analyst with Legg Mason, says that Gables has been a net seller of assets for the last few years. In 2003, for example, Petrik projects that funds from operations (FFO) will be about $9 million short of the amount needed to cover dividends, but sales of assets will generate $13 million to $14 million in profits (price minus the cost of the properties sold).

"I don't think Gables gets credit (from some other analysts) for generating earnings from the sales of assets. This part never hits FFO and cash flow," Petrik says, adding that Gables has also done a good job managing excess cash, using it to buy back stock and pay off debt in addition to a portion being used to support the dividend.

"Wheeler gets it," Petrik says. "Their focus is on providing total return for shareholders. They have one of the highest dividends in the sector."

		Upside-Downside Samplings of what analysts are saying about Gables Residential Trust...

Relying on Models

In order to provide those returns Gables depends on sophisticated modeling tools to buy properties in targeted markets when prices are soft, and looks to sell when the analysis shows the market near or at a peak, according to Wheeler. The models analyze publicly available information like demographics, economic base, etc., as well as additional demographic and local market information that Gables purchased to augment its database.

Wheeler, who has a degree in physics from the California Institute of Technology and an M.B.A. from Harvard University, says Gables relies more on modeling than most other REITs.

"We make investment decisions based on locations that our models show can beat the NAREIT Apartment Index," Wheeler says, adding that the company not only beat the index in the first and second quarters of 2003 but over the previous three and five-year periods as well.

Gables Mizner on the Green, Boca Raton, Fla.

Gables Palma Vista, Boca Raton, Fla.

The locations that can beat that index are usually in what the company calls Established Premium Neighborhoods (EPNs), defined as areas with higher per-square-foot prices in single-family homes. The EPNs, in affluent areas in cities, have 20 percent higher growth rates than suburban areas, according to Wheeler.

"The single-family home market is very efficient at pricing quality of life, such as schools, commute times, safety and entertainment," Wheeler says. EPNs are also usually located in employment or shopping centers. Therefore, they have a high cost of land and limited land supply, creating barriers of entry for competitors. By locating in the EPNs, Gables can compete with higher cost single-family homes and maintain high rents in desirable neighborhoods.

Typical properties Gables owns contain 200 to 350 units. In areas where there's enough concentration of smaller properties that can share a single manager, Gables has collections of 40 to 50-unit properties. Once a property exceeds 350 units, it requires another level of management, raising overhead costs, according to Wheeler, which is why he says Gables avoids those types of properties.

The number of people in their early 20s, which tend to comprise the majority of apartment dwellers, has been falling for the last 15 years. That trend is ending, however, with increases expected in that age group for the next 15 years as the echo boom generation goes out on their own.

Focusing on Sub-Markets

Gables continues to refine its targeted demand-driven markets and EPN locations as it exits some areas partially or totally and invests in others. In the last few years, Gables has exited certain markets such as San Antonio, while reducing ownership in other markets such as Tennessee and Orlando but continuing fee-management pursuits. The company has added properties in Washington, DC and other core markets.

"The company's done a pretty good job of transforming its portfolio in the last three years," Petrik says. "The company has focused on a specific set of submarkets and has gotten out of Nashville, Memphis and other non-strategic areas." As already mentioned, fee management, however, continues in these markets.

Petrik also approved of the way that Gables is shifting its portfolio away from areas with lower barriers to entry—and more potential competition—and toward areas with higher barriers to entry, like its EPN areas.

Gables also looks to balance its investments in cities that are counter-cyclical, Wheeler adds. The company's models have shown that some of Gable's eight investment areas are counter-cyclical with each other. So one area is typically up while another is down, helping to even out the fluctuations of the national economy, according to Wheeler.

To further pursue this strategy, Gables purchased Gables Woodley Park in Northwest Washington, D.C. for $53 million in July. Gables Woodley Park, built in 2001, is an 11-story high-rise with 211 apartment homes averaging 841 square feet. The purchase increased Gables' holdings in the nation's capital to 5,505 properties.

Banks says Gables wants to increase its Washington, D.C. presence to the point where 15 percent of the company's total revenues come from this area. The level today is only 4 percent.

Analysts say further movement into the Washington, D.C. metro region should benefit Gables over the long term. Harris points out that the market has little room to build new apartments or homes.

In the REIT's Sun Belt communities, the barrier to entry is much lower, Harris says. Though there might be higher barriers to entry in Gables' EPNs in these cities, there is less expensive land and properties nearby which means more actual or potential competition.

Harris and Petrik also see Gables' announced plans to move into the San Diego and Riverside-San Bernardino regions of California as giving the REIT more desirable properties in areas with high barriers to entry.

So far, however, the barrier to entry has been high enough that Gables has yet to enter these markets. The company has only identified them as targets for future investment.

Looking to the Future

Over the short term, Gables, like other apartment REITs, is battling the weak economy, poor demographics, lack of jobs and low interest rates as much as it is dealing with its own internal strategies.

Harris says the weakness in the overall apartment market, more than weakness in Gables itself is why Lehman Brothers lists the REIT as an "underweight."

Beyond the nationally recognized recession that many economists feel is finally past us, the apartment industry also suffered from the demographic trend. According to Petrik, the number of people in their early 20s, which tend to comprise the majority of apartment dwellers, has been falling for the last 15 years. That trend is ending, however, with increases expected in that age group for the next 15 years as the echo boom generation goes out on their own.

According to Wheeler, these echo boomers are the teenage children of the nation's approximately 80 million baby boomers. This generation accounts for as much as 30 percent of the U.S. population, making them as big or bigger than their parents' generation.

Gables West Park Village at Westchase Tampa, Fla.

Gables Rock Springs Atlanta

Gables West Park Village at Westchase Tampa, Fla.

With these echo boomers swelling the 18 to 30-year old demographic for the next several years, Gables officials expect a surge in demand for quality housing. Some 60 percent of this age group rents their homes due to a desire to maintain lifestyle flexibility and personal, economic and social circumstances.

The last time there was such a dynamic demographic was in the 1970s and early 1980s, according to Gables. At that time, the apartment demand ratio was one for every four jobs created, rather than the typical one for every six jobs, the company says.

The early stages of the echo boom have started but have been offset by recessionary influences (most notably a lack of jobs), according to Banks, who adds that the impact of the echo boom will increase quite dramatically in 2005 and beyond.

Assist From Higher Interest Rates

Demographics notwithstanding, interest rates and the job market need to change before the apartment business sees a rebound, according to Petrik.

With low interest rates, people who would otherwise be apartment dwellers are buying homes. With higher interest rates, some of these new homeowners wouldn't qualify for mortgages.

"It's hard to determine where interest rates are headed and we don't pretend to think our crystal ball is better on interest rates than anyone else's," Banks says. "The key for Gables (and its investors) is relative performance. No one knows for sure where interest rates or rental rates will go, but we are very confident that Gables will outperform other companies with investments in the same markets and Gables' strategy will allow it to outperform the national average over time."

"Usually in a recession, you can close the ‘back door' [people moving out of rentals to houses] because of high interest rates, but we've had historically low interest rates," Petrik says.

"It's hard to determine where interest rates are headed and we don't pretend to think our crystal ball is better on interest rates than anyone else's." —Marvin Banks

Petrik pointed out that Gables and similar REITs appreciated in late June through early August, when the average rate for a 30-year mortgage increased from 5.21 percent to more than 6.25 percent, according to the Freddie Mac weekly mortgage survey. Petrik says that a dip in rates would mean a dip in what investors could earn on bonds and other investments, so the stock shouldn't reverse even if rates did go back down.

But that still leaves the question of jobs. The potential demand among echo boomers, be it one apartment for every four jobs or one apartment for every six jobs, means little if the jobs aren't there in the first place.

Job growth is already occurring in Gables' core markets, Banks says. Atlanta and south Florida both had higher absolute job levels in June and July than in any previous June or July.

Petrik also cited increasing job levels in Gables' core markets. If this trend continues, Gables could start reaping the benefits of the echo boom generation moving into young adulthood and out of their parents' homes sooner than expected.