Housing
Falloff Hasn't Troubled REIT Funds
By DIYA GULLAPALLI
December 26, 2006; Page C1
Real-estate focused mutual funds are
shaping up as the best
Investors should rein in their
expectations for the coming year, but they aren't entirely late to the
situation. While the housing market has slowed recently, real-estate mutual
funds have remained mostly unaffected. The reason: They tend to focus on
real-estate investment trusts, which receive special tax consideration and
acquire and manage properties like offices, malls and apartment buildings.
![[Chart]](WSJ061226Housing%20Falloff%20Hasnt%20Troubled%20REI%20Funds_files/image001.gif)
REITs
have been seeing a flurry of mergers and acquisitions, which has pushed up
stock prices. At the same time, there is a healthy outlook for rentals and
occupancy rates, which help drive profits.
Real-estate funds dipped briefly last
year but are now the best-performing
Even many of the worst real-estate funds
have delivered twice as much as the average
Investors are attracted to real-estate
funds because of their steady dividend payments, as well as their benefits as a
way to diversify their overall portfolio, since real-estate funds can run
counter to other stock and bond investments. They've continued piling in, with
real-estate funds seeing $1.5 billion in net inflows in October, or 40% as much
as was generated for all of last year.
"A lot of the low-hanging fruit over
the last several years has been picked off the tree," but "it doesn't
mean investors can't do well with the sector over the long term," says Joe
Rodriguez, a manager for the roughly $2 billion AIM Real Estate Fund.
Still, managers like Mr. Rodriguez say 7%
to 10% average annual returns over the next five years are more realistic for
the category. Spotting the right mix of real-estate plays can be tough
sometimes, and even top managers have struggled to put enough into REITs.
CGM Realty Fund is among the
best-performing real-estate funds over the past three and five years, but has
fallen behind most of its peers for the year. The reason: The fund held a 25%
stake in mining stocks at the end of June, which has since been eliminated.
"In retrospect, I wish I hadn't been so invested" in those stocks
since they weren't "as strong performers as REITs,"
says the fund's manager Ken Heebner.
Alpine U.S. Real Estate Equity Fund also
had one of the best three-year track records for real-estate funds at one point
last year, but is now dead last among peers with negative 2.6% returns for the
year to date. The fund was one of the few real-estate funds invested in home
builders, with more than 50% there last year before trimming to 30%. "Home
builders got whacked, and hotels have been doing pretty well but not as well as
we'd like to see," says Sam Lieber, manager of
the fund.
Many top-performing real-estate funds had
an international bent, and several new products were launched this year. This
includes an international real-estate exchange-traded fund from State Street
Global Advisors, DWS RREEF Global Real Estate Securities Fund from DWS Scudder,
and ING International Real Estate fund.
Many managers identified two key factors
that, in retrospect, helped real estate funds this year. One was the amount of
merger-and-acquisition activity that occurred, such as last month's blockbuster
announcement that Blackstone Group is acquiring Equity Office Properties
Trust for $20 billion plus $16 billion in debt assumption in the largest
real-estate deal in history.
The second factor is more technical.
There was a narrowing in "capitalization rates," which are basically
expected net rent in the first year of an investment, divided by the price of a
property. Cap rates measure the rate of return in the first year of ownership,
and such narrowing suggests high prices for deals done in the past year -- and
big expectations for rent growth in coming years.
Real-estate watchers are generally
predicting a favorable outlook for REITs in the next
year. A Goldman Sachs Group Inc. report last month predicted a continued
recovery of occupancy and rental rates and favored areas like office and
industrial properties with long average lease terms, given expectations for a
slowing economy next year.
And this fall, fund-researcher
Morningstar Inc. noted plusses for REITs like high
home prices forcing more people to rent, making it a landlord's market. At the
same time, high prices for commodities needed to build new properties has kept
the supply of new buildings low.
Of course, it's not an entirely rosy
picture. Real estate funds have been volatile over the past few years,
returning 4.5% in 2002, between 30% and 40% in 2003 and 2004, and 12% last
year. Stocks have become pricier as an array of deals have
helped boost prices.
The average 12-month yield for real
estate funds has also declined to 2.21% last month from 2.86% last year and over
4% about five years ago, suggesting REITs are
becoming less attractive compared to say, long-term bonds. A slowing economy
and potential interest rate cuts next year are main concerns on many
real-estate managers' minds.
"What could change everything is if
the economy craters or there's too much supply or job growth grinds to a
halt," says Jay Rosenberg, a co-manager for First American Real Estate
Securities fund, one of the top real estate funds with over 35% returns so far
this year compared with 13% for the S&P 500.
Write to Diya Gullapalli at diya.gullapalli@wsj.com1
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