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Real Estate & REITs
Re: Pick 6 ('04)

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By 782gear
January 2, 2004

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Here goes nothing. With about 25 REITs, mostly blue chips, I'll be very happy to take my dividend and few percentage points at the end of 2004; yet, I don't feel any great sense of confidence in saying I believe it will happen. I suppose that if all the new money that crowded into the REIT sector, which gave us an unpredicted and extraordinary 2003, finds some comfort here, we will be fine. But, who is to say it will stick around when the economy starts to provide faster growing profits again in C-Corps. It makes no sense on a macro-economic level for the real estate on which these companies operate to be more profitable than the businesses which operate there. We are on new and untested ground. I ceratinly didn't predict such great returns in 2003 and have no idea where we will go in 2004.

I also don't feel that I can pick the sector which will outperform the others next year. I certainly like the industrial and warehouse sector (I've overweighted that sector for several years), but feel the current stock prices sufficiently discount the prospects of increased demand there.

Raymond James just posted a great report that suggests the office sector should be overweighted.

With Equity Office sitting with several million square feet of empty space (larger than many REITs), even if they have to lower rents a little on expiring space, they should be able to grow FFO if the Bushies can convince finance, insurance, and real estate companies to hire a few more office pinkies.

The apartment sector has been extremely well covered recently. The problems of this sector are, well, "in the market" so to speak, but with all the problems of the sector, many stocks are at 52 and, in a few cases, all time highs, discounting I guess the pick up in occupancy and rents in 2005/06.

Retail REITs have been on a tear, outperforming even the retailers. How long can that go on? The graphs of Chelsea and General Growth could launch a space ship.

I'm just not sure that real estate is going up at the rate of 60% per year. At least nothing in my rather limited experience has prepared me to accept an asset that grows NOI 5% - 7% per year growing in value at 60% for very long.

So, what should these slips of paper that pretend proportional ownership to the abstract equity represented by these real estate companies be worth now or at the end of 2004? I have no idea. What if I just try to pick a few companies that I think will be around at the end of 2004. They should earn enough to keep the lenders away from the door and the rating companies happy, pay their shareholders a below average dividend, and have a little free cash flow left over to pay down debt, to buy in shares if they start to get cheap enough, or to buy additional real estate if they can find some.

Starting with the A's, I like Alexandria (ARE), which specializes in drug peddlers like Merck (MRK), Pfizer (PFE), Wyeth (WYE) and Bristol Myers (BMY). The drug companies spend on average 15% of gross revenues on research. ARE provides, among other things, the real estate, including very specialized and expensive tenant improvements, for research labs for these companies. If they can grow FFO by 7% this year, pay a miserly $2.30 dividend, that should be good enough for 2004.


I like the PS sisters, Public Storage (PSA) and PS Business Parks (PSB). PSA owns 30% of PSB, they share office space, and the major decisions are made by the same bunch. They also share the fear of borrowing too much money, and love preferred stock as permanent capital. They should be voted the most likely REITs to still be here at the end of next year. The executives would have to steal your equity to fail these two companies, and they actually had a husband/wife team try it a few years back. They fortunately were discovered through internal sources and promptly fired before they cornered the market on PSB's toilet paper and janitorial supplies. PSB just grew by more than 20%, acquiring 3.6 million square feet in Phoenix, Orange County, and Miami.

A conference call will be held on January 8 to discuss the transaction.

In community and neighborhood shopping centers, I like Weingarten (WRI) and Regency (REG), both with well covered debt, dividends, and good growth prospects. If apartments do well, these guys should do better. They grow on the same demographics (population growth, household formation, and income), have better located real estate, and a higher percentage of willing renters. If residential growth (buyers or renters) is present in an area, demand for neighborhood and community shopping centers will surely follow. Of the two, I'm most familiar with WRI, which I've owned and added to the position every year since about 1990. They also own some NNN industrial, which causes some analysts to call them unfocused; but they have owned and managed the industrial properties for as long as I can remember with no major problems.

My final candidate for 2004 is Catellus (CDX), holder of some well located rail served real estate, which will serve to warehouse and ship from rail sidings on the left coast the growing demand for manufactured goods arriving from East Asia. Manufacturing jobs in the US has steadily dropped over the years to only 14 million, and could go as low as 8 million over the next several years according to some economists. The demand for those same goods has steadily increased in the US and in Europe. Instead of going through the Panama Canal, increasingly containerized goods bound for Europe from East Asia are being off-loaded at Western Ports, shipped by train to the Eastern Ports, and reloaded onto shipping for Europe, which is proving in some cases to be cheaper and faster. It also requires some additional warehousing, although Union Pacific reports it is quite an efficient move from ship to rail and back to ship again.

While I would like to win the contest next year, what I really hope is that I don't lose my ass along the road to retirement. All I want from my REITs is that they send me the advertised dividend, reinvest the free cash flow wisely, report their results to me fully and honestly, and treat me fairly as a stakeholder.

Have a great 2004!

Best Regards,
Gear


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