VALUE ADDED


Real Estate. Really

Steven Goldberg

You might want to tiptoe back into this sector because some real estate companies with lots of cash will be big winners.



It's the worst of times and the best of times for publicly traded real estate companies.

The bad news is all too obvious. The economy is shrinking, retailers are shuttering their doors and companies of all types are tightening their belts. Meanwhile, billions of dollars in commercial real estate loans are coming due this year, and new loans are incredibly difficult to obtain -- and expensive for those who can get them. "There's barely any credit out there, and credit spreads have blown out to wide levels," says David Lee, manager of T. Rowe Price Real Estate (symbol TRREX).

For many real estate companies, 2009 will be a year of struggling to survive. But for other companies -- those lucky enough or smart enough to have a lot of cash and low debt -- 2009 will be a year when they can start picking up distressed properties and companies at fire-sale prices.

Poised to thrive are the strongest real estate operating companies and real estate investment trusts (REITs). Stockholders will share in this bounty.

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Here's why. Publicly traded real estate companies are, in general, better financed -- and have better access to capital -- than private companies. They also have lower debt levels than most private companies. "Any company that is in a position of relative strength in terms of its balance sheet has an opportunity coming out of this darkness to take advantage of some of this weakness," Lee says. "Public companies have the ability to tap the public markets."

In a world of "eat or be eaten," the publicly traded firms are in a better position to feast than many private firms, particularly those that are small and underfinanced.

Real estate stocks have already discounted much, perhaps all, of the damage to come. Stocks of publicly traded real estate companies have been collapsing for almost two years now. The Dow Jones Wilshire REIT Index has already plunged 14% so far this year through January 15. In 2008, the index lost a record 37%. In 2007, it fell 17%. (Unlike real estate operating companies, REITs are required to pay out nearly all of their income every year.)

Never have REITs fallen so far. The index lost a mere 34% in the deep commercial real estate recession that accompanied the savings and loan bust of 1989 and the early 1990s.

Here's the interesting thing about that earlier REIT selloff. REIT stock prices hit bottom in late 1989 -- four years before commercial real estate prices began to turn up. During the early 1990s, REIT prices surged, as investors anticipated better times ahead.

Could that same pattern repeat itself this time? "The question is how much has already been priced into REITs," says Lee.

Lee won't venture a prediction on how his sector will do this year. But he has only 5% of his fund in cash -- for redemptions and to take advantage of opportunities. He's buying up REITs that own grocery store-centered malls and the cream of the regional malls. "We're either heading back to the Dark Ages, or we will have some sort of recovery because the consumer is the main driver of the economy," he says.

The fund is a fine choice for REIT investors. It yields 6.7% and charges expenses of just 0.73% annually. Lee, 46, has been on the job more than a decade and has tracked real estate since 1995. Over the past ten years through January 16, the fund returned an annualized 8% -- a hair more than the Dow Jones REIT index.

Personally, I prefer another fund, Third Avenue Real Estate Value (TAREX). The main reason: Less than half of its assets are in REITs. Manager Mike Winer, who spent many years in the real estate industry before becoming a professional investor, likes the freedom that real estate operating companies have to deploy their earnings. They don't make the huge payouts to shareholders that REITs must. In today's market, where cash is king, operating companies often have much bigger cash troves than REITs do.

Third Avenue is quirky. It yields just 2.9% -- low for a real estate fund. Expenses are higher than I'd like to see them, at 1.1%. Plus, Winer can -- and does -- invest anywhere; more than 60% of the fund's assets are in foreign stocks.

But returns have been solid. The fund gained 8.5% annualized over the past ten years. Winer is a disciple of Third Avenue founder Marty Whitman's "safe and cheap" school of investing. (Note that the fund has a $10,000 initial minimum, although many discount brokers let you in for less.)

I wouldn't dive into this sector. There are just too many uncertainties surrounding the economy in general and real estate in particular. But I think it's time to start tiptoeing in, investing a bit every month. I don't know how the stocks will do this year, but I have little doubt that this sector will produce solid returns over the long haul.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.




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