"I think there's a trade-off between what the assets are worth and what the management is worth," says John R. Nikolich, managing director of Mercury Partners LLC, whose firm based here and in Greenwich, CT provides investment banking, financial advisory services and equity research to real estate owners. "What is the value of management? Ten percent? That's an important thing to look at."

So is the capitalization rate used to establish a value of the real estate, Nikolich adds, as even a 25-basis-point uptick can significantly reduce its worth.

A REIT investor's due diligence should include a look at insider trading, Nikolich suggests. For example, when REITs were declared "dead money" compared to the high-flying NASDAQ issues in 1998-99, insiders were buying shares of their companies' stock, often with loans. In the second quarter of 2000, "shrewd money" was buying REIT shares Nikolich considered depressed. Now, when REITs are being touted as a hot ticket to double-digiti returns, Nikolich has noticed insiders are sellers.

"Why are insiders selling?" Nikolich asks.

While REIT dividend yields certainly look attractive compared to other investment alternatives, Nikolich cautions investors to keep an eye on the principal. "By the amount of press we're getting, the fact it's leading people into REITs is concerning to me," Nikolich says, troubled that some buyers may see the industry as the next NASDAQ growth ride.

"If you invest right now, you might get 7% to 8% (dividend return), maybe 9% to 10% in health care," Nikolich says. "But you're not ahead if the price of the stock goes down 20%."

Not that Nikolich is completely bearish on REITs. "You need to be selective and you need to be in the right sectors," Nikolich says.

In his view, safer REIT bets are apartments and self-storage facilities. On the other hand, office REITs with a high concentration in central business districts as well as hotels rank among the riskier when last week's tragic events in New York City and Washington, DC are added to microeconomic conditions of both sectors.

Why self-storage facilities?

"They're not co-related to the economy," Nikolich explains. The need for storage space is more obvious in a robust economy, he continues, but homeowners forced to downsize are among the new customers during a slowdown. The sector hasn't seen overbuilding, he adds.

Instant Insights /

REITs Still Worth a Look -- But Closely

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