Real Estate Not Without Bright Spots
January 29, 2008 - Real estate stocks and funds continue to lag in performance, thanks to fallout from the subprime mortgage meltdown. But there are a few signs that the worst might be over.
Real estate funds tracked by Morningstar Inc. (NASDAQ:MORN) were down 19.74% for the 12 months ended Monday. It was the worst performing domestic equity fund group.
But so far this year, its -1.12% return was second best behind bear funds’ 11.33% gain.
IBD’s REIT industry group ranks No. 63 of 197 groups, up from No. 141 four weeks ago. Real estate developers and real estate operations also have rallied off recent lows.
The Dow Jones Wilshire Residential Real Estate Index is at 116, down 32% from a high of 171 over the past year. But it rallied 15% in the past month after troughing out at 101.
Glimmers of improvement include a slight uptick in estimated housing purchases for 2008. The National Association of Realtors estimates 5.7 million homes will be sold in 2008, little changed from an estimated 5.65 million last year.
The Federal Reserve’s latest round of rate cuts will help lower the cost of borrowing for new homes, but it will take some time for that effect to work its way down to sales.
The picture remains brighter for commercial real estate. It’s less interest-rate sensitive than residential. The sector responds more to broader economic trends, such as hiring numbers.
“What’s going on in housing shouldn’t affect strip malls,” says Andrew Gogerty, mutual fund analyst at Morningstar.
The Dow Jones Wilshire REIT Index, which is loaded with commercial real estate issues, has fallen 31% to 207 from its 52-week high of 298 in February. It has rallied 16% from its low of 179 earlier this month.
Bright Spots
Paul Gray, portfolio manager at Kensington Funds, sees some good values. “We still see companies we own trading at a discount to what we think the company is worth,” he said.
AvalonBay Communities AVB is one such stock. The developer and owner of multifamily units made up about 5% of the $65 million Kensington Real Estate Security Fund KREAX on Sept. 30.
It’s trading at about 96, 35% below its February high of 148. But the company’s earnings and revenue have risen for all but two quarters since mid-2004.
AvalonBay also has exposure to the San Francisco and Boston markets, where rents tend to stay high.
The stock appears to be trying to form a bottom at 80 and recently regained its 50-day moving average line in strong volume.
Industrial real estate is in a similar position as commercial, in which investor perception may be out of sync with reality.
For example, Digital Realty Trust (NYSE:DLR PRA) (NYSE:DLR PRB) (NYSE:DLR) DLR manages real estate for tech companies. The REIT recently tested and held above its July low. The stock, which is yielding 3.2%, has an IBD Relative Price Strength Rating of 79, up from 51 two weeks ago, and an Accumulation/Distribution Rating of B.
Earnings and revenue have grown at a steady 30%-plus clip.
Digital Realty as of Sept. 30 was one of the top 10 holdings of CGM Realty Fund CGMRX.
Thanks largely to a 55% weighting in industrial materials producers as well as such fertilizer firms as Potash of Saskatchewan POT and Mosaic MOS, CGM Realty was the best performing real estate fund for the past year. It returned 20.75% going into Tuesday.
Digital Realty made up 5.12% of the $1.9 billion fund.
International real estate funds have performed better than their domestic counterparts.
Of the five real estate funds that Lipper Inc. shows had positive 2007 returns, four were international.
In the past year, the top international real estate fund was CGM Realty. It was followed by three share classes of Cohen & Steers (NYSE:CNS) Asia Pacific Realty APFAX, with 2.34% to 2.75%.
Demand for homes and commercial space in developing nations is one driver for the outperformance.
Reasons For Skepticism
Some are skeptical that a recovery will come soon. Morningstar’s Gogerty says it will take some time for perceptions about real estate to change.
Michael McGarr, portfolio manager and analyst at Becker Capital Management, says he estimates another six to nine months before the home builders or multifamily stocks start to come back.
“Looking at new home inventories, I’d say, yeah, it’s looking better,” he said. “But the total inventory is still going up.”
He sees the latest signs of life in real estate as a false dawn.
Even with the drop in interest rates, which usually helps home buyers, and a fall in prices, McGarr says it will take months for the inventory to get used up and for homes to become affordable again.