Betting on the House
Sam Lieber's affinity for homebuilders propels his real estate fund to the top of the charts.
By Manuel Schiffres, Executive Editor
From Kiplinger's Personal Finance magazine, August 2005
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Even with the big advance since 2000, the stocks still sell for just 8.5 to nine times estimated 2005 earnings, on average, despite average returns on equity [a measure of profitability] of 26%. That compares with a P/E of 17 for the S&P 500 index, which has an average ROE in the high teens. In the 1980s and early '90s, the stocks sold for two-thirds of the S&P's P/E. That means they should trade for at least 10.5 to 11 times earnings today. At any rate, I see several more years of earnings growth for homebuilders. This is definitely not the time to sell the stocks.
What's your favorite homebuilder stock? I'd have to say it's Toll Brothers. It's a great story. The company has developed a niche as the only nationwide builder that caters to the luxury-home market. It's tough to develop a brand reputation in this business, but Toll is doing just that. Eventually, Bob Toll will want to sell the company. This will be the big deal in the housing business, because Pulte will want it, Lennar will want it, and Horton will probably take a run at it. And the most logical acquirer would be General Electric because it already provides products, financing and services in this sector. Why GE has not bought a homebuilder yet I don't know. Maybe these companies aren't big enough.
Is there a common thread among the homebuilders you own? They all generate high returns on equity and on invested capital. But different companies employ different business models. D.R. Horton, for example, has acquired other homebuilders to enhance earnings growth. Others, such as Ryland, are growing by going into new markets, buying a piece of land, putting down a trailer and building there.
What do you have against the few homebuilding stocks you don't own? I don't want to buy companies that are heavily in the Midwest. I don't mind companies operating in Chicago, but if you look at home prices and you look at population growth, you don't want to be in places like Lansing, Mich., or Columbus, Ohio.
Most funds in this sector have the bulk of their assets in real estate investment trusts. Your fund has only 20% in REITs. Why so little in that group? First, we do have a fund, Alpine Realty Income & Growth, that specializes in REITs. The fund was launched in 1998, when REITs yielded 9%, on average. Today, REITs yield less than 5% and trade at historically high ratios of price to funds from operations and other earnings-type measures. Thus, they are less interesting. Plus, the supply-demand dynamics in areas such as offices and apartments, where many REITs operate, aren't as compelling as they are in housing.
Do you have a favorite REIT? Vornado Realty Trust. It owns prime office space in the New York City and Washington, D.C., areas, certainly among the best markets. It owns shopping centers and also owns one-third of Alexander's, a New York-area real estate play that has been one of our favorite stocks for a long time.
You are more bullish on hotels, right? Yes, we have 26% of the fund in lodging stocks -- primarily operating companies, but also some hotel REITs.
What's the case? Once again, it's econ 101 -- supply and demand. The year 2000 was a phenomenal year for hotels. But then came a recession, then 9/11, then SARS [severe acute respiratory syndrome] and the run-up to the invasion of Iraq. So we have more than two years of heartache during which no one wanted to travel. The emergence of travel Web sites, such as Priceline and Orbitz, also hurt hotels. The big chains were so desperate for customers that they'd send these Internet companies blocks of rooms for whatever price they'd pay.
But the hotels have improved their own Web sites and now give away far fewer rooms to the Internet players. Meanwhile, demand for hotel rooms has recovered. Last year demand grew more than 4.5%, and this year it should grow at least as much as the overall economy -- figure 3.5%. The supply of hotel rooms was up about 1% last year and should be up 1.4% this year. With demand for rooms exceeding new supply, hotel companies are starting to get pricing power and that means greater revenues and profits.
What's your favorite hotel stock? I'd have to say La Quinta. It's run by a guy named Butch [real name: Francis] Cash, who used to run Red Roof Inns until it was bought by Accor. La Quinta is very heavy in the South and Southwest, particularly Texas. The company wants to expand its national presence, and it's doing that by adding more franchises. Most of its hotels carry either the La Quinta or Baymont brands. It will probably buy a third chain. Meanwhile, the stock is cheaper, on a price-to-cash-flow basis, than Hilton or Starwood, two other big hotel chains, and the company is much smaller than those two, which means it should be able to generate faster growth. It's a good story for the next couple of years.
--Research: Christine M. Varner