Companies focused on highly specialized property types may offer a lot to investors, if they can get them to notice.

By Phil Britt

Niche or specialty REITs, those REITs whose investment focus are highly specialized, are often the Rodney Dangerfields of the REIT industry. Since their business doesn't fall neatly into the primary sector classifications and they have few, if any, direct REIT peers, they have to work extra hard to gain the "respect" every public company wants from analysts and investors.

But for a company flying below the radar, what comes first, building a core investor base or attracting sustained analyst coverage? In attempting to generate interest in their companies, these REIT executives say they have to aggressively go after both. Analyst coverage can help garner investor interest and interest from a large investor base can help convince an analyst to spend the additional time needed to research a specialty REIT, says Bill Bayless, chief executive officer of American Campus Communities, Inc. (NYSE: ACC). Larger institutional investors may introduce specialty REIT management to analysts, or analysts may connect the management with investors.

"When presenting to an analyst, you spend more time looking 'out the back windshield,' on past history," says David Brain, CEO of Entertainment Properties Trust (NYSE: EPR). Entertainment Properties owns movie theater locations. "When you talk to investors, you spend more time looking 'out the front windshield' looking at the company's future."

The message the specialty REITs try to deliver to the analysts and investors are similar in many instances. Specialty REIT executives focus on the financial history of their companies as well as on what makes them different from other REITs or other non-REITs in a similar business.

"It's real estate with a twist," Brain says. What we have is more exciting than just another equity REIT."

Brain adds that most pension fund managers mark their success by their performance against certain indices. By simply purchasing shares of more "common REITs," they'll have more traditional returns. However, buying a quality specialty REIT, they have a better chance of beating the performance benchmarks, he says.

Analysts and specialty REIT executives agree that a niche-oriented company can help generate interest among investors and analysts through a presence at NAREIT meetings, and other industry and investor conferences.

Obtaining Coverage

Many of the smaller niche REITs don't have a dedicated investor relations department, so they don't have an internal marketing engine to help generate analyst interest. However, size isn't necessarily a cure for gaining attention—even the larger specialty REITs with in-house IR professionals fight an uphill battle, as in the case of Plum Creek Timber Company, Inc. (NYSE: PCL), a member of the S&P 500. Despite being one of the largest equity REITs, Plum Creek still has only a handful of analysts (and those are non-REIT analysts) who follow the stock, according to Rick Holley, company president and chief executive officer.

Lou Taylor, senior real estate analyst for Deutsche Bank Securities, explains that there are only a limited number of analysts at the firm, so there are physically only so many companies that they can cover.

"If there was rapid consolidation in the [real estate] industry that would create some extra capacity for us, then we might consider covering some of the niche players," Taylor says. "If companies want more [analyst] coverage, then they have to get bigger. Even then there's no guarantee."

Despite being one of the largest equity REITs, Plum Creek still has only a handful of analysts (and those are non-REIT analysts) who follow the stock, according to Rick Holley, company president and chief executive officer. —Rick Holley Plum Creek

Ross Nussbaum, senior real estate analyst for Banc of America Securities, says each individual analyst firm makes its own determination of what, if any, specialty REITs to follow. Nussbaum and his team follow Capital Automotive REIT (NASDAQ: CARS), which owns auto dealerships, and Correctional Properties Trust (NYSE: CPV), which owns correctional facilities.

Both REITs operate net leasing businesses, which operate much like other, more traditionally categorized REITs, Nussbaum explains, though he admits it took a little more research time to understand these companies and their operations than it would have for a more typical office or retail REIT.

(Editor's note: At press time, Capital Automotive signed a definitive agreement to be acquired by clients advised by DRA Advisors for $3.4 billion. DRA Advisors is a real estate fund that manages approximately $3.6 billion in assets. In June, DRA agreed to acquire another REIT, CRT Properties Trust.)

And what of the other niche market REITs? Banc of America Securities' timber/paper products analyst follows Plum Creek and the telecom analyst researches Global Signal, Inc. (NYSE: GIS), a REIT that owns wireless communication tower locations. But no one at the firm follows Entertainment Properties Trust.

Citing proprietary information, Nussbaum declined to say what specific factors determine whether or not a company receives coverage. He did admit that size is a major factor, though if a company "has an interesting story to tell," it may get coverage even if it is smaller than most companies the analysts follow.

Defining Assets

Market capitalization of at least $500 million is the first determinant of what companies Deutsche Bank covers, a floor that some specialty REITs can't meet. In the case of Plum Creek, however, it is well above that threshold with a more than $2 billion equity market cap. However, Plum Creek's business focus falls more in line with Deutsche Bank's analysts in paper products and lumber, so those specialists provide the coverage.

Explaining the differences between the specialty REITs and the more commonly followed REITs or even non-REITs is one of the most daunting tasks facing these REITs, according to company executives.

For example, Plum Creek is strictly a timber company, not a paper products company like International Paper (which has announced that it plans to divest itself of its timber operations) or Weyerhaeuser, which are largely dependent on the sales of their downstream products. This makes Plum Creek distinctive, since it can better determine its own destiny. If timber prices are low, the company cuts fewer trees that year, Holley says. When timber prices are high, the company cuts more trees.

Analyst coverage can help garner investor interest and interest from a large investor base can help convince an analyst to spend the additional time needed to research a specialty REIT. —Bill Bayless American Campus Communities

But many analysts still don't get it, according to Holley, who describes the beginning of his discussions with many of them as "Timber 101."

Even some of the analysts who did "get it" when Plum Creek first went public said they no longer understood the company when it converted to a REIT in 1999, according to Holley.

What complicates the situation, according to Philip J. Martin, senior vice president at Stifel, Nicolaus & Company, Inc., is that Plum Creek has significant land holdings. So the land has to be considered as well as the timber itself. Spending a lot of time researching a company when there's only one in a sector, like Correctional Properties, may not provide the most efficient use of time for an analyst, some specialty REIT executives admit.

However, Capital Automotive CEO Tom Eckert says it's not all that different than an analyst covering a retail or other REIT. The company still has to explain why it is different than other REITs to generate positive coverage among analysts and interest among investors.

Others say that being different is just the factor that attracts some investors to these REITs, says Bayless, whose American Campus Communities develops on-campus and off-campus student housing as well as operating already existing on-campus facilities.

Analysts and investors sometimes categorize American Campus as a multifamily housing REIT. While there are some similarities in the broadest sense, there are quite a few differences, Bayless says. As a result, he spends much of his time explaining the unique characteristics: From August to May, there are virtually no vacancies (and close to 100 percent vacancies during the other two months of the year); the "tenants" are new every year; and, unlike multifamily housing, once the tenants are signed up each year, there's no additional turnover. Multifamily housing units, on the other hand, have an 8 percent turnover each month, according to Bayless.

Pursuing the Analysts

It used to be a little easier to get analyst coverage when the relationship between analyst and investment banking functions were more closely aligned, according to Bayless. If an investment firm wanted to profit from an investment relationship, it would initiate coverage along with handling the deal. So the more financing deals the REIT conducted, the more coverage it received.

Recent events have resulted in the separation of the analysis and investment side of the house, though this type of quid pro quo may still exist to some extent, Bayless suspects.

The analyst coverage is easier to get once a company is seasoned, Brain says. Brain's Entertainment Properties Trust, founded in 1997, has developed a following from analysts at large as well as at some smaller firms.

In the early years, Entertainment Properties Trust had to keep the business simple so that it was understandable for analysts and investors alike, Brain says. There was no coverage in exchange for financing deals in the early going because Entertainment Properties was investing its own capital.

"When presenting to an analyst, you spend more time looking 'out the back windshield,' on past history. When you talk to investors, you spend more time looking 'out the front windshield' looking at the company's future." —David Brain Entertainment Properties Trust

By making the story simple, the company could explain the financing easily to an analyst or investor who may not be willing, at least initially, to devote a lot of time to the company. More recently, Entertainment Properties has become involved in joint ventures, secured debt and other complex financing that is more difficult to explain.

Capital Automotive's Eckert had similar experiences. When the company started in 1998, it was difficult to get coverage, particularly because it wasn't in a position to seek investment banking deals and generate revenues for the investment banking firms. That changed in 2000 as the company's rapid growth resulted in the need for more financing, leading to more coverage.

But the financing-for-coverage isn't the only factor in the REIT's growth from no analyst coverage to 11 firms now following the company, according to Eckert.

"You have to work the process. You have to build relationships in the analyst community. You have to be credible with the analysts; they need to be able to trust management and what management says," Eckert explains.

So meeting or exceeding guidance in terms of financial performance is important. Analysts don't want surprises to the downside.

"You're usually more successful if you pursue the analyst than if you wait for them to call," adds Eckert, who credits company Chief Financial Officer David Kay for taking the time necessary to cultivate analyst relationships.

Just as the long-term success of a company like Capital Automotive, Entertainment Properties Trust or American Campus will generate more interest among analysts, it will also generate more interest among competitors who will enter the market, according to Bayless. He points out that two other companies owning student housing have gone public in the last year, generating more interest in the sector from analysts and investors alike.

Coverage at some firms is dependent on the presence of certain analysts, Brain says. For example, Entertainment Properties enjoyed coverage from some analysts at smaller firms. Once those analysts moved to a larger firm, coverage followed as well.

On the other hand, the company had coverage from major firms Goldman Sachs and Morgan Stanley, which handled the IPO, but lost the coverage when analysts left their firms, Brain says.

Additionally, just because an analyst moves from one firm to another, it doesn't guarantee a change in coverage. For example, when analyst Brian Atchison recently moved from Prudential, where he had covered Entertainment Properties, to Merrill Lynch, the latter didn't immediately pick up coverage. Brain is still hopeful that Merrill Lynch coverage will be forthcoming.

Making a Case

Stifel, Nicolaus' Martin advises niche REIT executives to clearly describe their business and operating philosophy to analysts and investors. Executives need to explain why their FFO and other financials are better than those of other, more easily comparable equity REITs.

For example, Capital Automotive, one of the specialty REITs that Martin follows, has stable cash flow throughout the economic cycle, Martin says. Most of the ups and downs of the economy are borne by the auto manufacturers, not the dealers.

Eckert agrees, pointing out that most of the incentive plans, pension costs and other challenges the auto industry faces are handled at the corporate level. The dealers themselves profit far more from the sales of used cars, financing, insurance and repairs than from the sales of new vehicles.

To investors, the financial message and explanation about the company may be augmented with a discussion on the number of offerings, according to Eckert. The more offerings, the more opportunities the investment fund manager has to buy significant blocks of equity.

"You have to work the process. You have to build relationships in the analyst community. You have to be credible with the analysts; they need to be able to trust management and what management says." —Tom Eckert Capital Automotive

"As they perform better than other REITs, they become hard to ignore," says Sean P. Smith, equity research analyst for Stifel, Nicolaus & Company, who follows Entertainment Properties. "It all goes back to performance and the ability to consistently generate positive returns and good cash flow."

One of the reasons that St. Louis, Mo.–based Stifel, Nicolaus covers Entertainment Properties is because it is based in Kansas City, Mo., meaning it's of greater interest for regional investors, Smith adds.

Entertainment Properties is stable, with good growth prospects, Smith says. Though a niche player, the company still operates in the business of long-term net leases, so some of the basics of analyzing the company are similar to those of other net lease REITs in other sectors, according to Smith. "There is some familiarity there. If they were doing something else, then it would be a little more difficult."

Smith adds that Entertainment Properties has a high-quality portfolio, with two-thirds of the company's megaplex properties ranked in the top three in their respective markets. One hundred percent of the company's theater assets are currently occupied.

If a specialty REIT has that type of positive story to tell, analysts and investors alike will tend to listen, analysts and executives say. However, the story will have to be told again and again, because the niche REIT will likely have to start with analysts at smaller investment firms and investment professionals (pension fund managers, etc.) looking for something beyond "plain vanilla" holdings for their constituents.

However, in this age of transparency and increased financial scrutiny, the companies also must have clean financial histories, accessible and reputable management and a business that can be explained in a way that intrigues analysts.