TAKING STOCK         

REAL    RETURNS     by John Rubino

Conventional wisdom says that low inflation is good for stocks. Stable prices calm capitalists’ nerves, making them more likely to commit money to new ventures and expansions. The result: rising corporate profits and higher stock prices. But a recent Barron’s column asked this question: What if we’ve got the relationship backwards? “Suppose inflation has little impact on stocks? Suppose, instead, that the stock market has a major impact upon inflation?”

Think about it: In a bull market, cash gushes into stocks. That’s money that might otherwise be spent on cars, clothes and TVs, driving up the price of consumer goods and causing inflation. So the tame inflation of the past decade and a half, rather than being the cause of the booming stock market, might be its consequence.

View the past through this new lens, and you see inflation sloshing back and forth between tangible assets and financial assets as people shift their resources into whatever is relatively cheap.

Between 1966 and 1982, for instance, stocks fell 73 percent in real terms, while inflation raged. Then the tide shifted, and the value of U.S. equities rose from a piddling 30 percent of the gross domestic product to more than 100 percent today. The current level, by the way, is unequaled, exceeding even that of pre-crash 1929.

Interesting. And alarming. If our revisionist history is right, the pendulum is getting ready to swing big time in the coming decade, with cash flowing out of relatively expensive stocks and into relatively cheap “real” stuff.

And because nothing is more real than land and buildings, perhaps it’s time to revisit REITs – real estate investment trusts. These companies bundle hotels, office buildings and apartments into portfolios, then sell stock that trades on the value of the underlying properties.

Because REITs are required to pay out most of their earnings as dividends, investors tend to view them as income vehicles. But if real estate prices start to accelerate, they can also generate big capital gains.

The number of REITs that are either headquartered in the commonwealth or own a big chunk of local terra firma has grown in recent years, so investors have a wider selection than ever before. Here are six, each one recommended by at least one Virginia analyst or money manager:

Resource Mortgage Capital (RMRPO, $27.63), based in Richmond, is technically a REIT, but it acts like a savings and loan. It lends money to people building apartment buildings and manufactured homes, then either keeps the loans and collects the interest or “securitizes” them by bundling them together with other loans and selling the package at a profit. With earnings rising by more than 35 percent, 1996 was a fun year. Resource Mortgage’s price is up by considerably less, so the yield on its stock is around 9 percent, about 2 percentage points above long-term Treasury bonds.

United Dominion Realty Trust (UDR, $15.75) is a Richmond-based REIT that has appeared in this column several times. It specializes in apartment buildings and is widely regarded as one of the best-managed companies in the business. It yields about 6 percent. Nuff said.

CarrAmerica Realty (CRE, $29.50) is one of the biggest property holders in the D.C. area. But in recent years it has been diversifying into other, faster-growing cities like Denver and Austin. It’s big, with a market capitalization of about $1.5 billion, and it’s financially solid thanks to a recent stock offering. Yield: 6.5 percent.

Mid-Atlantic Realty Trust (MRR, $10.75), headquartered in Linthicum, Md., owns 21 shopping centers and eight other commercial properties, mostly in Baltimore and metro Washington. It’s selling off non-core assets – including 151 acres of undeveloped land – and using the proceeds to make strategic acquisitions. Alex Hart with Ferris, Baker Watts in Baltimore notes a lower-than-average dividend payout ratio and a higher-than-average dividend yield. That means the stock already pays well, and its dividend could go up faster than other REITs in coming years. Yield: 8 percent.

Charles E. Smith Residential Realty (SRW, $28.35) in Crystal City owns 38 apartment complexes and two malls in the D.C. area. It’s benefiting from the comeback in Northern Virginia property values and yields about 7 percent.

Humphrey Hospitality Trust (HUMP, $8.50) in Silver Spring, Md., is a brand new REIT that just went public. It owns nine midquality hotels like Best Western and Comfort Inn, five of them in Virginia. It’s small, with a market capitalization of $30 million, but it is using the proceeds from its initial public offering to buy more property. Yield: 9 percent.

The REITs’ combination of current yield and capital-gains potential has already begun to stir the market’s interest. During the past year, they kept pace with growth stocks, rising by roughly a third. But – again, if the new theory is right – there could be a divergence coming, in which stocks based on the future earnings of cookies and software lose their luster, while those based on land and buildings keep on chugging.

John Rubino, a free-lancer specializing in public companies, is writing a book about investing in local stocks.