| http://www.barrons.com/bie/articles/current/toc.html
March 25, 1997
Looking for the REIT Stuff
Howard R. Gold
Performance Snapshot | Cohen's Picks
REAL ESTATE'S COMEBACK
OFFICES AND REGIONAL MALLS LEAD THE WAY
FAVORITE STOCKS IN THE OFFICE SECTOR
CHOICE REGIONAL MALLS
An interview with Martin Cohen. After a spectacular [Image]
year in 1996, real estate investment trusts have
gotten the attention of many investors, from yield-hungry
value players to noted technicians like Ralph Acampora.
Investing in REITs, which usually don't move in tandem with
the overall market, is now seen as a good way to diversify
stock portfolios, especially in light of the stock market's
huge run. But what's ahead for REITs and how to play it?
Barron's Online turned to Marty Cohen, president of Cohen &
Steers Realty Shares, for his insights into the real estate
market and REIT stocks. The fund, which Cohen launched in
July 1991 with his partner Robert Steers, has grown into the
largest mutual fund specializing in REITs, with $2.8 billion
in assets, has consistently topped the S&P 500 since its
inception.
Barron's Online: Last year was a banner year for REITs. Your
fund rose by almost 39%, vs. about a 35% total return for
equity REITs, beating the S&P 500 dramatically. What worked
so well last year?
Cohen: First, you had a strong economy that kept the real
estate recovery moving forward. And in fact, last year you
started to see very significant declines in vacancy rates in
most major property classes--industrial, office and
apartments. So the real estate recovery had a full head of
steam, and still does. The effect of that was material on
REIT earnings--across the board, you had about a 10 percent
rise in earnings of REITs and about a 6% growth in
dividends.
Q: Are you measuring earnings by net income?
A: No, funds from operations, FFO, which is essentially net
income plus depreciation, with a few minor adjustments. It
is basically a measure of cash flow of the company.
Third, REITs had not done as well as stocks as a whole, so
on a relative basis REITs looked very undervalued. I think a
big change took place last July, when REITs went up and
stocks went down--further evidence that REITs do lead a life
of their own, provide portfolio diversification. That turned
psychology even more positive.
Q: So basically people started investing more funds in the
industry.
A: Yes, capitalization of REITs is now reaching close to
$100 billion, so they are able to accommodate very large
investors--pension funds and mutual funds.
REAL ESTATE'S COMEBACK
Q: Not so long ago, back in the early 1990s, we had a
horrible real estate economy. Yet right now, we are clearly
doing very well. Can you trace how that happened?
A: In the early 1990s you had a liquidity crisis. The
savings and loans were legislated out of business. The banks
were forced to lower their real estate investment. The tax
laws were changed so that individuals could no longer get
tax benefits. There was no money for real estate. And then
you had this recession during 1990-1991. As a result, you
had a dramatic decline in property value.
Q: That was around the time you and Bob Steers formed Cohen
& Steers Realty Shares.
A: July 1991.
Q: Was that at the very bottom of the market?
A: It was probably the very bottom of the real estate
market, although there was still going to be some pain in
the next year or two. REITs bottomed in October-November of
1990. It is always gloomiest at the bottom. But in any case,
we did get that fund off the ground and it has enjoyed
nothing but good returns and good growth.
REITs were the only group that hadn't fallen prey to the
excesses of the 1980s, because they didn't have access to
capital from banks; there were no tax benefits in owning
REITs in terms of write-offs. Institutions didn't put money
into REITs. So they were pretty much left standing, and when
there was a liquidity crisis in real estate, they picked up
the pieces.
Cohen's Picks
Company Ticker Price
Cali Realty CLI 34 3/8
Crescent Real Estate Equities CEI 59 7/8
General Growth Properties GGP 30 3/4
Highwoods Properties HIW 34 3/8
Public Storage PSA 28 7/8
Rouse Co. RSE 29 7/8
Vornado Realty Trust VNO 69 �
Q: They were probably some of the only vehicles available
for financing.
A: Yes.
Q: Obviously a lot of things are coming together--a strong
economy, reasonably low inflation and interest rates and
very little new building over the last few years--and REITs
had a terrific year last year. In fact, in the fourth
quarter of 1996, I believe 19 out of the 20 best-performing
mutual funds were REIT funds. Isn't that performance too
good to continue?
A: I hope not. I have four kids I want to send to college.
Q: I don't mean gloom and doom. I am just saying, obviously
you did so well, it is hard to repeat a performance like
that.
A: If you look back in history, you find that even when
REITs have had great years like last year, they have still
managed to do well. They are off to a pretty good start this
year. I don't think we'll have another 40% year, but I think
you can have a mid-teens total return, which is a reversion
to their mean performance over the course of the years. It
looks like we will finish this quarter up about 4%-5%, and I
am not unhappy with that. Some people are calling and
saying, what is wrong with REITs? I don't know. What is
wrong with REITs? I am not going to make any excuses. There
are none to be made.
Q: So, you feel this may be a nice 15% or so year. You say
that in your annual report "this year may be somewhat more
challenging than the last."
A: I am trying to reduce expectations.
OFFICES AND REGIONAL MALLS LEAD THE WAY
Q: Yet you feel that a couple of the major sectors of the
industry have very strong fundamentals--the office sector
and the regional mall sector, both of which were lagging
pretty badly a couple of years ago. What do you find so
appealing about those sectors?
A: The office sector is the most exciting today, because we
have now seen a decline in vacancy rates. There is very
little new construction, there had been overbuilding and
there's not a lot of money available for speculative office
development. But that is changing. There are also a
tremendous number of office buildings for sale by large
institutions and pension funds. And REITs are the ones with
the capital and the know-how to make those acquisitions.
Plus, with the declining vacancy rate, you are starting to
see a very healthy increase in rents. Landlords are getting
their power back.
Q: That is certainly happening here in Manhattan--in midtown
at least.
A: It really is. I think over the next several years, if you
own an office building you are going to see steadily
improving profits as your occupancy rate goes up and your
rental rates go up.
In the regional mall sector you have a similar picture,
although it is somewhat earlier than in the office cycle.
Regional malls were not terribly overbuilt and there are
today only a handful a year being built, but with sluggish
retail sales, consolidation of the department stores, and
until recently, a pretty good number of bankruptcies of
tenants. Over the past year, a couple of things have
happened. One is that the department stores have done
extremely well--the shakeout of the small tenants has ended.
And this year, I think for the first time in some time you
are going to see an increase in occupancy rates--that is,
you are going to see a diminution of bankruptcies.
Q: I remember actually writing stories in which
knowledgeable people said the regional mall was dead. A lot
of them were really having problems in the late 1980s, early
1990s.
A: They were dead for a good number of years. But in the
last year or two they have started to come to life. We are
seeing better fundamentals there. And as long as the economy
stays strong, I think that is going to continue.
FAVORITE STOCKS IN THE OFFICE SECTOR
Q: If those are your two favorite sectors in the industry
right now, which are your favorite stocks?
A: In the office sector, Crescent Real Estate Equities.
[Image]
Q: That is Richard Rainwater's vehicle.
A: Yes. Then Cali Realty, which is a major office owner in
Northern New Jersey and now Westchester. They bought the
Robert Martin Co., which has a very strong hold in
Westchester County. What they are doing, interestingly, is
they are not just buying property, they are also buying the
management with them. They are building their management
organization. And the third one there is Highwoods
Properties, which is in the Raleigh-Durham, NC area. It has
started to diversify by radiating out of Raleigh-Durham into
Charlotte and Nashville and Richmond, into Southwest
Florida. So they are diversifying away from being a company
in one metropolitan area to being much more diversified.
Q: That mid-South area in particular is very strong
economically and has been remarkably recession-resistant.
A: There is growth in population, growth in jobs.
Q: Would you talk a little bit about Crescent? Obviously
that company gets a lot of coverage.
A: Crescent is what I would characterize as more of an
entrepreneurial company. With regard to the Rainwater
strategy, a major thrust of the company is the office
sector. But they just bought some psychiatric facilities
from Magellan on what I think were favorable terms. They
also own some luxury hotels. So they are a little more
entrepreneurial. The earnings are growing at a dramatic
rate.
Q: Aren't they trading at a high valuation?
A: They are, but I think it depends on what measure of value
you use, whether you believe they will be able to continue
to grow. I believe they will be, based on the management.
The properties they have in place are going to grow because
of those factors I mentioned--the higher occupancies and
higher rental rates.
CHOICE REGIONAL MALLS
Q: In the regional mall area it seems your biggest position
is in Rouse Co., which is kind of an unusual regional mall.
They operate the South Street Seaport and Bayside in Miami
and some other "festival marketplaces," as they used to call
them.
A: They also have the Staten Island mall, and they also own
traditional regional malls.
[Image]
Q: Wasn't that specialty mall concept kind of a fad a few
years ago? Isn't it a little bit less popular now?
A: The promise was greater than the actuality.
Q: But you are still positive on the prospects for Rouse.
A: We are very positive, and what really got this company
and the stock moving was their acquisition of the Howard
Hughes portfolio of Nevada. It includes Summerland, which is
a large residential community, and also properties in and
around Las Vegas.
Q: That has been the fastest-growing large city in the
country for a number of years. Any others in the regional
mall area that you particularly like?
A: I like General Growth Properties, which is our second
largest holding in this sector. General Growth is an
extremely well-managed company. They have made some
significant acquisitions over the last year or two. Some
thought they overpaid. But when they took over, they applied
their management technique to make them financially more
profitable. I call them one of the best property management
companies.
Q: There is also something called Public Storage in which
you have a large stake.
A: Public Storage is one of our largest holdings, period.
And it is a company that, of course, owns or controls 11,000
of those ugly orange signs. It also has the largest chain of
storage facilities, which are in very strong demand
nationwide. They have made an operating business out of
this, which is different from a real estate business. They
have an 800 number, which is like a reservation system, and
it has helped increase the occupancies at all their
properties. For instance, if you call and you say, I need a
place in the Bronx, they will say, "We don't have anything
available in the Bronx, but we have something in southern
Westchester. Does that work for you?"
[Image]
They have also gotten into retail. They sell goods now at
these storage facilities. You can buy packing equipment and
things that you need when you store things. They will rent
you trucks at some of their facilities. They have a pick- up
and delivery service now, which is very innovative.
Q: They have managed to leverage their facilities very
smartly.
A: Yes. As a result, they are enjoying absolutely dramatic
growth.
Q: One more that I wanted to ask you about has been in the
news an awful lot. You have a large position in it--Vornado
Realty Trust.
A: Vornado is poised today to become one of the largest real
estate owners in the country, and they have always had a
very strong entrepreneurial management team. They have added
Michael Fascitelli, formerly at Goldman Sachs. In their
first major transaction, they have acquired the Mendik Co.,
which is a large owner of Manhattan office buildings. They
also are in negotiations with several other very large real
estate enterprises.
Q: So you think they are just really getting started in this
area.
A: They are just getting started.
Q: What is your view of the potential of REITs over the next
few years?
A: There is a massive transfer of ownership taking place
from private to public finance. And as this continues, REITs
will only grow, and I think they will grow in size only if
they can do so profitably, because being in a public market,
they are under the microscope of analysts and investors. As
long as there is discipline on the construction side--which
we believe there will be--you won't have the volatility in
the cycle that you had in the past, so I think the outlook
is good for the next several years. Eventually this cycle
will come to an end, and there will be a time when real
estate is out of favor. We don't know when that will happen,
but I don't think it will be in the next couple of years.
Q: Just to wrap things up, you see a lot of opportunities in
this sector. You don't think 1997 will be as spectacular as
last year, but certainly a very good year going forward.
Thanks a lot, Marty.
Performance Snapshot
Since
1996 Three-year Five-year Inception
2-Jul-91
Cohen & Steers
Realty Shares 38.5% 18.6% 18.9% 18.7%
S&P 500 (Total
return) 23.1% 19.7% 15.2% 16.5%
S&P 500 (without
dividends 20.3% 16.7% 12.2% N.A.
reinvested)
Fund results reflect compound annual return
N.A. = Not Available
Source: Lipper Analytical Services, Ibbotson
Associates; Cohen & Steers
[BARRON'S Online]
Copyright � 1997 - Barron's Online, All Rights Reserved
Two World Trade Center - 18th Floor
New York, NY 10048
[Dow Jones & Company, Inc.]
We welcome your comments, questions and feedback.
|