Analysts at Milwaukee-based Robert W. Baird & Co., in astudy that examines all categories of REITs, say they continue tolike "out-of-favor suburban office names" that nonetheless hold thepotential for significant earnings improvements once the capitalmarkets stabilize.

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One reason for the Baird analysts' preference for suburbanmarkets is their view of suburban versus CBD markets. "Contrary topopular opinion concerning the supply-constrained nature of CBDoffice markets, it appears these markets may in fact have moresupply as a percentage of inventory than suburban markets,"according to their report.

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The Baird report cites Corporate Office Properties Trust ofColumbia, MD, which owns suburban holdings like InterQuest BusinessPark in suburban Denver; along with Indianapolis-based Duke RealtyCorp. and Los Angeles-based Kilroy Realty among the office REITsthat it expects to outperform the market. Comparing office REITs toREITs in other property sectors, the Baird analysts say that theyexpect healthcare, student housing and storage REITs to be the bestperformers among the property classes, but they expect that allother categories of REITs--including office--will offer stablereturns despite the economic and real estate downturns.

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The Baird analysis--authored by David AuBuchon, David Loeb,Christopher R. Lucas and Paula J. Poskon--points out that virtuallyall REITs are trading at prices below the net asset value of theirunderlying properties. Office REIT stocks are trading about 10.5%below the net asset value of the underlying properties incomparison to hotels, which is trading at 22.6% below net assetvalue; multifamily, 12.7%; industrial, 14.2%; net lease, 4.3%;shopping centers, 17.1%; storage REITs, 12.6%; and student housing,8.7%.

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The figures suggest that, despite all that has happened in theeconomy and the credit markets, the properties that the REITs ownare still worth more than their stock market capitalization despitethe economic woes of the past year.

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Like other property owners, office REITs are facing a slowingeconomy, a lack of liquidity, declines in office payrolls, slowingmanufacturing employment and other factors that are dragging downdemand. Baird's report points out that declines in office payrollshave totaled 391,000 since the July 2007 highs although theseremain well below the more than 1.1 million jobs lost during the2001-02 recession. Manufacturing has lost about 383,000 jobs sinceJuly 2007, compared to nearly 1.8 million during the previousrecession.

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The Baird analysts say that they "are encouraged by the relativeresiliency of the labor markets," but add that the prospect offurther, more pronounced declines "remains a primary risk to realestate."

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Of course, REIT performance will vary from company to company.The Baird team points out that, given that the debt markets remainin disarray and lenders continue to foresee conditions worsening,well-capitalized REITs "stand to benefit greatly" from theopportunity to buy discounted assets as a result of capital marketsconditions that will force some owners to sell.

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Despite some cautions regarding the economy and capital markets,the Baird analysts cite a number of factors working in favor ofoffice REITs. "Leasing activity at this point in the cycle hasactually been relatively strong," they say. And, and rent growthalso has been consistent while "broad-based tenant credit issueshaven't surfaced yet." A number of REITs have turned to jointventures and other investment fund structures to preserve capital,the report notes. The publicly held REITs have also benefited fromreduced private market competition as a result of more conservativeunderwriting by lenders.

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