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2 new twists to real-estate investing
Amid all the talk about a home-price bubble, commercial and overseas real estate are areas that could still handsomely reward investors.
By Timothy Middleton
The six-year rampage staged by real-estate stocks is showing no signs of fatigue. Doubters, including me, have been proved wrong again and again as returns from mutual funds investing in the group have rocketed ahead more than 20% annually.
One way mutual funds invest in real estate is through REITs, or real-estate investment trusts, a tax-advantaged form of property ownership that revolutionized the sector in the United States 15 years ago.
Now foreign governments are beginning to adopt similar laws, and many real-estate investors say a whole new era of profit opportunity is dawning abroad. You can buy real estate in Japan now for less than you could 10 years ago, says Samuel A. Lieber, manager of Alpine International Real Estate (EGLRX). In Germany, valuations havent changed in 10 or 15 years.
With stocks trading sideways and bonds in an interest-rate flutter, investors are desperate for alternatives. My inner Grinch says that could set investors up for a fleecing, and Im hardly the only skeptic.
Of course, even REITs historical returns of around 10% a year are alluring at a time when stock prices go up 4.9%, as the S&P 500 ($INX) did last year, and bonds eke out a gain of 2.4%, as the iShares Lehman U.S. Aggregate Bond Index (AGG, news, msgs) did.
So if you are considering getting into the property game, rather than getting out, here are some justifications, and some very handsome funds to consider.
A routine 100% gain
The heartbeat of commercial real estate is the demand for space, which in turn is driven by employment. The U.S. unemployment rate is 4.7%, a figure that was considered impossibly low just a decade ago.
Related news and commentary on MSN Money
Job growth is the primary driver in commercial real estate, says David M. Lee, manager of T. Rowe Price Real Estate (TRREX), a fund. You are seeing occupancies rise, and when occupancy gets to a certain threshold, pricing power returns to landlords.
In addition to higher rents, a rise in occupancy rates pushes up the value of existing buildings. Higher prices in construction, forced in part by booming demand for materials in China and India, inflates the cost of putting up new structures.
Five years ago you bought a building for $100 million, putting up $50 million in equity, says Martin Cohen, chief investment officer of the Cohen & Steers series of real-estate mutual funds. He notes that 50% leverage is the norm in the commercial-property market. Today the building is worth $150 million, so your equity has doubled.
A doubling of a REITs value, therefore, is not a bubble but a routine adjustment of price to value, he asserts.
Values double in five years if they compound at a 15% rate of growth. At real-estate funds, growth has been more robust than that.
| MSN Money masters: Top real-estate funds | | Fund | 5-year annualized return | 12-month yield in % | Biggest industry weighting* | | Alpine Intl Real Estate Y (EGLRX) | 21.5% | 1.17% | Home builders | | T. Rowe Price Real Estate (TRREX) | 21.2% | 3.31% | Office, retail | | iShares Cohen & Steers Realty Majors (ICF, news, msgs) | 21.0% | 3.7% | Retail | | Cohen & Steers Realty Shares (CSRSX) | 20.5% | 3.11% | Apartments |
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Notes: As of Jan. 31, 2006. *Among top 10 holdings. Sources: MSN Money, Cohen & Steers, Morningstar Inc.
Cohen and Lee are my favorite domestic real-estate managers. Both have low-turnover styles that reflect careful stock picking. Turnover is less than 30% at their funds, vs. an average of 100% in the property sector.
Incoming
Thats important because real estate is subject to at least two cycles: an overarching sensitivity to the business cycle, primarily in the form of interest-rate sensitivity; and the cyclicality of various industries, from retailers in regional malls to corporate tenants in office towers.
Focusing on the management of property companies allows these funds to reduce rapid price swings in their shares, and more stability translates into higher returns.
(Another fund and its manager, Third Avenue Real Estate Value (TAREX) and Mike Winer, would be on the above list if the fund were not closed to new investors.)
On the international side, my favorite manager is Alpines Lieber. He is also no slouch at running Alpine U.S. Real Estate Equity (EUEYX), which has spurted an average of 26.1% in each of the last five years.
Foreign real-estate markets are quite different, and one clue as to why is the relatively low yield of Liebers international fund compared with those of Cohen and Lee.
REITs pay much higher yields than operating real-estate companies; they have to in order to qualify for the tax break on their dividends. Overseas, REITs are commonplace only in Australia and South Africa, and to a lesser extent in Holland.
In the last three years weve seen France adopt the REIT structure with great success, Lieber says. Japan now has 26 REITs, and the first ones have been launched in Singapore, Hong Kong, Malaysia, Korea and Taiwan.
More importantly, Germany and the United Kingdom will probably create REITs this year or by the beginning of next year, Lieber continues. We see this as very beneficial, because it brings in a different kind of buyer for real-estate securities -- investors who want income.
Although REITs are stock-like and trade throughout the day as equities do, I regard them strictly as income investments. They play that role in my model portfolio (on Moneys ETF Center) of exchange-traded funds, which holds iShares Cohen & Steers Realty Majors (ICF, news, msgs).
Spreading your wealth
I dont think real-estate funds will appreciate in the coming five years the way they have in the last five, but I think their dividends can continue to supercharge an income-oriented portfolio. Retirees in particular should consider a real-estate sector fund as a key element of their portfolio.
In cocktail-party chatter, you might be warned away from real estate because it seems clear that a bubble in residential property is deflating, notably in San Diego and the other most-overheated markets.
But the correlation between commercial and single-family properties is low. The local papers in New York carry stories these days about falling home prices and rising office rents on the same page.
Thats a reminder that commercial real estate is a good portfolio diversifier, and therefore well worth owning, whether its popular or not. Just now, though, its popular indeed.
At the time of publication Timothy Middleton didnt own any securities mentioned in this article.
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