In Real Estate We Trust

     Thirty years ago Judy Lynn-McDowell and her husband, Michael McDowell, who live in Northwest Woods, were advised by the trustees of Mr. McDowell’s mother’s estate to invest in a real estate investment trust, offered by Merrill Lynch. They purchased 35 shares at $1,000 each in “downtrodden waterfront condos” in Southern California that were on the drawing board to be renovated. Alas, they never were.

     “One month I looked at the statement and it was gone. . . . That was it. It went belly up. There was no accountability whatsoever,” said Ms. Lynn-McDowell, who was once a financial trader and now works as a mortgage banker-broker out of her home for Amerifund.

      Her experience with a real estate investment trust is fairly typical (except the part about the disappearing developer). Shares are sold to finance a real estate project or to allow investors to profit from income-producing real estate. According to Wikipedia, the “REIT structure was designed to provide a real estate investment structure similar to the structure mutual funds provide for investment in stocks.” Since commercial real estate provides rent rolls, real estate investment trusts have historically been predominately commercial.

      However, that definition seems to be changing, at least as Simon Harrison, a broker in Sag Harbor, is reinterpreting the concept. Under the assumption that Hamptons real estate is a valuable asset and that wealthy individuals are looking for ways to invest wisely, Mr. Harrison has built six “REIT portfolios.” Rather than purchase shares, investors are invited to buy residential properties. His latest, launched in September, comprises a dozen houses priced from $460,000 to $1 million. An investor can buy all 12 houses as a package for $10 million or each singly. So far five have been sold or are in contract.

     He is not marketing these in a home, sweet home with a picket fence kind of way, but rather as a “mix of equity bets and expansion candidates.” Mr. Harrison said he is “scaling [it] down to a micro level” to allow a “regular person to compete with mega people.” With no emotional attachment to a house, it becomes a commodity, something an investor “can dump easily,” he said. “They’re in it just for profit.”

       To attract buyers, he is using “a rental income approach.” He takes the example of a 9,000-square-foot, $10 million house on two and a half acres. Why buy that, he asks, when you can buy 12 houses totaling 25,000 square feet on 15 acres for the same amount?

       “It’s an automatic diversification of the same amount of money,” he said. “If a leader on Wall Street has $50 million of artwork, $50 million in commercial property, a $25 million apartment, $200 million worth of equities, $600 million of more conservative funds in bonds or treasuries, it’s not out of line to think that a rental portfolio in the Hamptons would be considered.”

       “A lot of people are coming to the same conclusion, that the Hamptons are a solid place to invest,” said Chris Chapin, a broker with Douglas Elliman. “There are big fish moving just below the surface.”

       Mr. Harrison said that people are walking into his office asking for investments. “We just send them the portfolios.”

       What is happening here is part of a larger national trend of marketing residential properties as investments. An article last month in The New York Times reported on an Australian investment trust that has purchased “more than 538 homes, townhouses, and brownstones from Jersey City to Queens and Brooklyn.” And that’s not all. Private equity firms, including the Blackstone Group, have bought “billions of dollars’ worth of single-family homes in some of the areas most affected by the housing collapse.” What these deals have in common with Mr. Harrison’s offerings are that they are offering “steady, dividend-like returns” from rentals.

       In his collateral, Mr. Harrison stresses the attraction of his properties — all in the Sag Harbor area — to prospective renters. The “strong school system” gets high billing. He estimates the year-round rent roll for his latest real estate investment trust at $420,000 per year, about the same amount you could get for renting your $10 million house for the summer. But theoretically, he said, you’ve got a lot more equity with his package.

       But is it an actual real estate investment trust? Michael Braverman, a partner in the now-defunct real estate firm Braverman, Newbold, Brennan, who still dabbles in real estate, understands that “with a REIT you own shares or parts of a bundled financial instrument. I’ve never heard of it being done on such a small scale.” To call Mr. Harrison’s listings a REIT, he feels, is “not accurate. It’s more an informal partnership.”

       But, what’s in a name?

       Mr. Harrison claims that he is “not reinventing the wheel, just bundling properties that meet certain criteria.” He admits that he has “never sold a whole package to someone. . . . For every single one people have come in and cherry-picked individual properties.” Who have his clients been? Mostly financiers — one who works at Merrill Lynch, another at Morgan Stanley — a real estate broker, an architect, an attorney at a financial firm. 

       There is an advantage for the seller too, he said. When a homeowner lists a property with him, he and his agents can sometimes fit it into “a puzzle that forms a larger investment vehicle that acts differently than an individual property.”

       His REITs (call them what you will), he believes, “satisfy varying customer needs for income, equity increases, as well as wealth preservation.” And, he stressed, “If you believe that the Hamptons aren’t going away, then the risk is low.”