STOCK WATCH


Get a Jump on a Real Estate Recovery

Jeffrey R. Kosnett

Real estate service companies are beaten down now but will outperform REITS as the economy strengthens.



Still shocked by all the red in your portfolio? These numbers will lift your spirits: gains of 441%, 498% and 1,020%.

Those are total returns during the recent property market heyday for three leading firms that engage in commercial real estate sales, leasing and property management. Those great times began in 2003 and ended last year.

If the credit situation stabilizes and the world economy holds up, these stocks have a good chance to go nuts once again. You'll get much bigger gains from them than you will from a real estate investment trust index fund or a broadly diversified real estate fund.

The first company is CB Richard Ellis Group (symbol CBG), whose 441% gain from when it went public in 2004 to the end of 2006 amounts to an annualized 96%. Jones Lang LaSalle (JLL) soared 498% in four years, or 56% annualized. The 1,020% return, worth 83% a year, came from Grubb & Ellis (GBE).

For comparison with other real estate investments, consider Ken Heebner's excellent CGM Realty fund (CGMRX). During this period, the fund made exactly 100%, or 19% a year.

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Of course, what went up also went down -- to a point. The real estate service shares have been clobbered over the last year, down by as much as 55% since peaking in 2007. They are excitable, to put it mildly.

Still, if you delve into the numbers, the big drops in these stocks' prices have been an overreaction. The U.S. commercial real estate sector hasn't collapsed nearly as badly as the housing sector. And in Europe, the Middle East and Asia, it's still expanding nicely.

All three companies are making money, though less than they did during the recent U.S. property boom. Analysts say that the halving of prices is more an anticipation that credit for big U.S. and European real estate broker deals will dry up. If that happens, fewer deals will mean fewer commissions for the likes of a CB Richard Ellis.

There are two flaws in that argument. First, credit may not collapse for these types of deals. Second, these companies are no longer simple brokers that depend only on commissions.

For example, of all of CB Richard Ellis's four business units, only commercial brokerage had a poor 2007. Property management for corporations, institutional real estate investment fund management and consulting combined to generate at least 26% earnings growth in 2007.

In its real estate investment business, CBRE has low risk. It manages $38 billion of property for pension funds and other institutional investors but has only a small direct ownership interest, less than $700 million.

And because CBRE makes half its profits outside the U.S., the depressed dollar helps its bottom line. This happens directly because money earned overseas is worth more in dollars. It also happens indirectly because overseas investors love relatively cheap American property, and CBRE is equipped to find it for them.

Despite these attributes, and a respectable fourth quarter of 2007, its shares fell from $42 in July 2007 to close March 12 at $18.72 a share.

Jones Lang LaSalle is similar to CBRE in geographic reach and mix of businesses, but is half the size. Here, too, the stock's decline is guilt by association. "It's all real estate," Lehman Brothers analyst Jeffrey Kessler wrote facetiously in February.

Kessler persuasively argued that a global and multifaceted real estate company with no subprime or residential-mortgage dealings, and with healthy growth, shouldn't lose half its market value for long. Jones Lang LaSalle has fallen about 40% from its summer high and closed March 12 at $73.98.

The fall in Grubb & Ellis is more understandable because it is far less global and gets a higher percentage of its income from "1031 tenant-in-common" property deals that it does with U.S. individual investors. TIC programs allow an individual to sell appreciated rental property and exchange the proceeds into real estate holdings with a predictable yield.

So an individual might sell a small apartment block and get a share of a Grubb-managed fund that owns low-risk properties leased to someone like Walgreen or Best Buy). Such deals not only take away the hassle of managing property, but also defer the capital-gains taxes. Grubb merged last year with a company called NNN Realty Advisors and is now the largest sponsor of 1031 tenant-in-common investment programs.

Grubb & Ellis also manages private REITs and has plans to open a group of open-end and closed-end real estate mutual funds.

Grubb still has its older business of managing and selling commercial property. As of the latest quarter, that business brings in 55% of the revenue.

But Grubb's strategy is to become more of an investment company managing REITs. Stocks of investment-management firms -- consider Eaton Vance and T. Rowe Price -- often give the stockholders better returns than the stock and bond mutual funds they run.

So the Grubb strategy is a test of whether the same idea will work for real estate funds. Not a bad idea, but given the real estate crisis, Grubb's timing hasn't helped its share price. It's also down about 40% from its summer high, closing March 12 at $6.69 a share.

When a dose of Federal Reserve credit easing and some other general optimism lifted the stock market March 11, Grubb shares gained 5.5%. Jones Lang soared 8% and CB Richard Ellis 8.5%. One good day doesn't mean the troubles are over. But it's a good indication of what these stocks are capable of doing when the markets beat the credit blues.




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