Dear Mr. Berko:

Crescent Real Estate Equities trades at $16.54 and pays a $1.50 dividend (reduced from $2 in 2001), which is a fantastic 9.1 percent current return. I own 200 shares that I bought at $37 in 1997, and as you can see I have a big loss. Do you think this stock fits well in a conservative income and growth portfolio? Would you recommend that I buy 200 more shares to reduce my basis?

C.A., Durham, N.C.

Dear C.A.:

I would not recommend the common stock of Crescent Real Estate Equities Inc. (CEI-$16.54) to an income and growth investor, but you might consider the purchase of CEI’s convertible preferred Series A, which trades at $20.28 and pays a $1.6875 dividend for a nice, warm yield of 8.3 percent.

This convertible preferred has no maturity, is redeemable at the issuer’s option at $25 a share and is convertible into 0.6119 shares of CEI common stock at the holder’s option. Because the conversion price is so far from the current market price, this is what is called a “busted” convertible.

CEI considers itself a little different from most real estate investment trusts because it is diversified into four very distinct real estate segments. Management wrongly believed that its unique diversification would enable the company to prosper through the various economic cycles of the real estate market.

The company owns 72 office properties (28 million square feet) in large metropolitan areas such as Denver, Las Vegas, Miami, Dallas, Houston and Austin, Texas. These huge offices are located in high-growth but often volatile local economies. Unfortunately for CEI, 83 percent of its office portfolio is in Texas, which is extremely susceptible to the weakness in the energy and the telecommunications industries. In fact, El Paso Corp., its largest office tenant, recently informed the company that it will vacate more than 900,000 square feet of space. CEI believes that El Paso will honor its leases (which represent 4 percent of the company’s rentable space) and El Paso thinks it can sublet its vacated space.

CEI’s resort hotel segment comprises five luxury resort/spas (1,050 rooms) and four upscale business-class hotels with 1,775 rooms. The occupancy rate for this group in 2003 was a respectable 71 percent.

The company’s residential development segment owns 23 very upscale residential development properties. It sold 78 lots in 2002 and 60 lots last year at an average price per lot of $653,000.

CEI’s temperature-controlled logistics business consists of its interest in 87 properties with 441 million cubic feet (17.5 million square feet) of warehouse space. In fact, the company and its partner own the largest refrigerated warehouse operation in North America.

All told, the company’s revenues for 2003 were $949 million, down from $1.01 billion in 2002, which were up from $696 million in 2001, which were down from $719 million in 2000. Earnings were 26 cents a share in 2003, 72 cents in 2002, a loss of 7 cents in 2001 and a huge profit of $2.05 in 2000.

This year CEI expects to book a loss of about 33 cents a share. However, funds from operations should come in between $1.45 and $1.55 a share. As a result, I believe the company’s board may cut the current $1.50 dividend to about $1 a share.

The yield of 9.1 percent will in all probability fall to 6 percent.

CEI is far from the best-run REIT in the industry, and management, including the board of directors, may be overpaid. Competitors such as Vornado, Developers Diversified, Washington and Cousins are certainly better managed by miles and miles.

However, I think that the next three to five years can be good for CEI. And there’s better than a remote possibility that if the next few years are kind, the common stock could return to the $40 level where it traded in 1997 and 1998.

So I’d really rather own the convertible at $20.28 with a much more secure 8.3 percent current return than the common stock at $16.54 with a potential dividend cut to $1. As an income/growth investor, I’d take the conservative approach and earn an attractive yield with the preferred and wait for the common to return to its old-time highs.

Many of my clients and I own shares of CEI Series A convertible preferred shares, which trade on the Big Board.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.