1-9-03                                                                                           Vol. 6: No. 1 RealtyStocks' Observer If you're not receiving this free monthly e-newsletter, please register. Monthly Feature: 2002 IN REVIEW: Retail and Mortgage REITs Shine, Non-REITs Suffer & REIT TRENDS IN 2003 A. 3-Years Straight: Markets Are Down, but REITs Are Up B. Eliminating Taxes on Dividends May Hurt REITs C. REIT Trends in 2003 D. Large Cap REIT Performance E. Equity REIT Performance F. Mortgage REIT Performance G. Realty Corporations H. Real Estate Mutual Funds I. Best Wishes for the Coming Year! A. FOR 3-YEARS IN A ROW: MARKETS ARE DOWN & REITs ARE UP This was the third consecutive year that major indices were down. The final 2002 tally was even worse than the year before. This past year the Dow Jones fell 16.8%, the S&P 500 dropped 23.4% and the NASDAQ plunged 31.5%. What are seldom looked at, however, are the drops from the peaks of these indices, achieved in early 2000, and the gains now needed to match these peaks. With the Dow Jones dropping -26% from it all time high, it would need to increase about 36%; with the S&P 500 declining -40% from its peak, it would need an increase of about 67%; and, with the NASDAQ falling -73% since its record high, it would need a monstrous surge of 350% to return to its pinnacle. In contrast, the REIT indices and many real estate mutual funds are near their peaks and are up around 30% in three years, even though dividends now represent most of this increase. However, the broader REIT market covered by RealtyStocks has performed even better over the last three years. Prices have risen 20% and overall returns are estimated around 40%. For investors focused on yield and safety the last three years who invested in bonds and REITS, times are not that bad. These investment havens have averaged at least several percent or more annually. Although most REIT indices showed relatively modest positive returns for 2002, of about 2% to 4%, they included dividends of several percent. So, the price of REITs actually declined within most REIT indices. Still, REITs finished around the top 10% of all industry groups for the third year in the row. However, as shown below, the broader price performance of Equity REITs covered by RealtyStocks was even better with a price gain of 5.86% that, together with dividends of several percent, indicates double digit overall returns for 2002. Although the core property groups declined last year, retail had an outstanding performance with a 13% annual price increase. Since there are four retail property groups among a total of 14 groups we cover, there is more weight given to retail by us than in the other indices. And, since we also cover Mortgage REITs, which jumped 22.07% in price for 2002, the overall price increase of All REITs we follow was up 9.6% thereby producing overall returns in the mid to upper teens last year. Therefore, most REIT indices that exclude Mortgage REITs and underweight retail with an emphasis on large cap stocks significantly underperformed the broad REIT gains of the past year. This also occurred in 2001, but in 2000 large cap REITS, especially the core properties including office, apartments and industrial, outperformed the broader REIT market. We expect that in the next year or two, large cap REITs and indices may be in a position to outperform the broader REIT market once again.   Top B. ELIMINATING TAXES ON DIVIDENDS MAY HURT REITs President Bush's proposal to eliminate taxes on dividends is becoming very controversial. When we addressed this topic last month, we believed eliminating corporate taxes on dividends would reduce the tax advantages of REITs. However, by changing the double taxation on dividends by eliminating dividend tax paid by individuals instead of corporations, it may have a greater perceived disadvantage for REITs. Since REIT earnings passed through to stock holders are already tax exempt, the most recent proposal to eliminate taxes will exclude REITS. So, if individuals do not need to pay dividend taxes on stocks in any other industry except REITs, they may feel disadvantaged. Consequently, as REITs loose a 35-year old tax advantage, they become less desirable to many investors. While the stock market has started the new year with a strong start, up several percent so far, the REIT sector has had more ominous beginnings with a loss of a couple percent. This may foreshadow things to come in 2003. And, even if the President's economic stimulus package regarding taxes on dividends does change in some respects, we do not believe REITs can 4-peat above the average of the market as a whole this year. In fact, REITs may be fortunate to avoid the bottom third of all sectors in 2003. The Bush administration's plan to exempt dividends from taxes has been criticized foremost as a bonanza to the wealthy. However, the Bush proposal believes that by making stocks that pay dividends more attractive, it will enable companies to raise more money by issuing stock instead of debt, reduce debt loads, decrease financing costs and also increase capital expenditures. Most importantly, it is also viewed as a way to spur consumer spending and help increase income to many retirees. It could possibly even lessen some burden upon Medicare and Social Security. But it is not without some serious concerns. First, eliminating taxes on dividends will cost the U.S. hundreds of billions in tax revenues over 10 years. This is a stagering amount that some believe will not enable the U.S. to maintain a balanced budget, require the need for greater federal borrowings and therefore cause higher interest rates. Second, tax free municipal bonds would probably loose much of their advantage, making the financing costs for cities, states and even the federal government more costly, thereby reducing services that are already declining. Third, corporations may feel compelled to increase dividends which could reduce or limit the amount they spend on capital expenditures. Fourth, if non-dividend paying stocks become less attractive, it may be more difficult to raise equity for IPOs and technology companies which could result in limiting technology advancement in the coming decade. Although the most current proposal provides a method to address this problem, it may be difficult and costly to administer. Expect to hear much more about the President's tax proposal, as well as some changes.   Top C. REIT TRENDS IN 2003 The increasing pressure upon REIT earnings we expected last year, only really began late last year. The impact of lower rents, higher vacancies and the resulting decrease in earnings and dividends for core commercial real estate (including industrial, office and retail properties) requires a lag time of several months and even a year or two because of longer term leases of 3, 5 or 10 years. But adverse conditions affecting such properties as apartments, hotels and public storage, which are not subject to long term leases, are realized sooner. As a result, the recovery of properties with longer term lease will also require more time than those with short rental terms. Office buildings, with 16% nationally, the highest since 1993, are of particular concern with regard to increasing vacancies and decreasing rent. In addition, the glut of sublease space in major office markets will also keep the lid on earning recoveries for office REITs for a while. Still, if there is a relatively quick recovery, office properties, as well as other properties under longer leases, could have less fluctuation in rent than those properties with shorter rentals. High profile properties, often commanding price premiums, may no longer be able to obtain adequate insurance coverage at affordable costs to totally protect against a calamity or future acts of terrorism. Because of much higher insurance premiums, insurable levels in some situations may become reduced hereby increasing risk to owners and REIT shareholders. Financing costs, that are at the lowest rates in about 40-years, are expected to increase this year. Although we do not expect much change in the first quarter, should the economy show some real improvement, rates could start to move up quickly. In the last two weeks, 10-Year Treasuries increased over 15 basis points daily (bps) on three occasions, while the largest daily downside involved only single digits. So, there seems to be a strong bias towards higher interest rates in the near term. Within this quarter or the next, a large move of 75 or even 100 bps could occur in a very short time, especially if the Iraq situation is quickly resolved, possibly by a short war or especially by the resignation of Sadam Hussein, for example. Such a rate jump could force larger and better quality REITs to be more active in the equity markets and reduce debt. For the smaller REITs with more limited opportunity to tap into public equity, higher financing costs could be an additional detriment against earnings. This, and the more limited liquidity of smaller REITS, could cause larger REITs to outperform their smaller siblings in the coming year. Consolidation in the coming year financing may be more likely among the smaller cap REITs. However, besides the recent attempt of Simon to acquire Taubman, we still expect some mergers or acquisitions among large cap REITs too. Valuations of commercial real estate have been quite strong and are probably peeking. Pressure for declining values is developing from softer rents and higher vacancies, but may be impacted even more by eventual increases in both short and long term interest rates. We will continue to discuss expected overall REIT performance, the best/worst property sectors, interest rates, equity market performance and general economic conditions in "RealtyStocks 2003 Forecast", available later this month to Members.   Top D. LARGE CAP REIT PERFORMANCE Large Cap REITs finished 2002 with a small price decline of -0.9%. The best large cap performer for the past year was General Growth Properties (GGP) which gained 34%, followed by Hospitality Properties Trust (HPT) increasing 24.7% and Prologis Trust (PLD) rising 16.9%. The worst performing large cap REITs for the year were Trizec Properties (TRZ), falling -42.8%, and Apartment Investment & Mnge Co. (AIV), dropping -18%. For December, the best performing large cap for December was Rouse Company (RSE), up 6.4%, and the worst performer was Health Care Property Inv (HCP), down -12.1%. (Please see Large Cap REITs.)   Top E. EQUITY REIT PERFORMANCE Equity REITS ended 2002 with a slight monthly gain of 0.66% and posted an annual increase of 5.86%. The best performing group last year was Retail Factory Outlets (up 42.8%) followed by Retail Malls & Center (up over 20%). The worst performing group last year was Hotels (down -10.8%). About half of the fourteen property groups were negative in 2002. The best performing stocks for the year were Center Trust, Inc (CTA) and Tanger Factory Outlet Centers, Inc. (SKT), gaining 83.5% and 48.7%, respectively. The worst performers last year were Golf Trust of America (GTA) and Meristar Hospitality (MHX), losing -70.9% and -53.5%, respectively. The best performing stocks for December were Golf Trust of America (GTA) and Highwoods Properties (HIW), gaining 9.8% and 8.3%, respectively. The worst monthly performers were Jameson Inn (JAMS) and First Union Real Estate Investments (FUR), losing -42.8% and -24.3%, respectively. (Please see Equity Gainers and Losers.).   Top F. MORTGAGE REIT PERFORMANCE This sector finished 2002 with a gain of 9.6%. For December, Mortgage REITs were in front of their Equity counterparts with a gain of 2.1%. The best performers for the year were CRIMI Mae Inc (CMM) and Dynex Capital (DX), up 152.9% and 130.5%, respectively. The worst yearly performers were Apex Mortgage Capital (AXM) and Impac Commercial. (ICH), losing -41.9% and -24.3%, respectively. For December, the best monthly performer was American Residential Inv. Trust (INV), gaining 28.4%, and the worst was Impac Commercial. (ICH), losing -11.6%. (Please see Mortgage Gainers and Losers.)   Top G. REALTY CORPORATIONS Realty and Housing Corporations finished 2002 below Equity REITs with a loss of -4.09%. The best yearly performer was Tech & Net with a spectacular rise of 65.8%. The worst yearly performer was Property Services with a drop of -20.9%. For December, OnSite Tech had a slight gain of 3.1%, respectively. The best performers for the year was US Realtel Inc. (USRTE.OB), up 176.2%. The worst yearly performers were Foster Wheeler Corp. (FWC) and Champion Enterprises (CHB), down -77.3% and -76.8%, respectively. The worst monthly performers were Foster Wheeler Corp (FWC) and Champion Enterprises (CHB), down -31% and -21.9%, respectively. (Please see Realty Corp. Gainers and Losers.)   Top H. REAL ESTATE MUTUAL FUNDS (REMFs) Overall, real estate mutual funds produced one of the better sector returns in 2003 with an average of 8.59% and outperformed most REIT indices. Nevertheless, REMFs did not match the broad based performance of REITs that RealtyStocks measures by about 4 to 8 percent. There were some bright spots, however. Four real estate fund managers managed to achieve total returns in excess of 20%. The best returns were achieved by Kensington Strategic with returns of about 30%, followed by Spirit of America, Alpine U.S., and Stratton Monthly Dividend. Still, it is somewhat surprising that only a few of the 147 REMFs were able to produce returns more than the broad based overall performance of all publicly traded REITs, or that more REMFs did not emphasize the better performing groups, such as Retail and Mortgage REITs. The best REMFs in December included those top performers for the year, including Alpine U.S. and Kensington. However, Advantus held the top spot with a total return of 11.57%. The average fund performance for December was 2.95%. (Please see REMFs.)   Top I. BEST WISHES FOR THE COMING YEAR! We wish everyone a healthy and prosperous New Year! Although we believe that the coming year will be much more challenging for REITs than in the previous three years, there should be some merger/acquistion plays with REITs and possibly some better opportunities among non-REITs. A new cycle could well emerge making it very unlikely for REITs to outperform the major equity indices 2003. In addition, we view the President's proposed economic incentives, especially regarding the elimination of taxes on dividends, to be potentially more damaging to REITs than might presently be expected. Nevertheless, we hope that RealtyStocks and newsletter will help you stay informed, assist you with your investments and possibly guide you to areas where some real estate stock jewels may shine in the coming year.   Top Stock Changes -no changes this month. Note: In reporting group percentage changes, stocks that were under $1 are excluded from our calculations. If a stock is under $1 for more than two months, it is subject to removal from our coverage. All gains or losses regarding Realty Stocks are price changes only; dividends are excluded. Disclaimer: The material provided herein should not be taken as endorsements or recommendations to invest in a stock, fund, a group of stocks or other securities. No guarantee can be made as to the expected performance of such investments. Investors should consult all available information, including data external to RealtyStocks and associated Web sites, and exercise own best judgment before making any investment decisions. The author may have equity positions in some of the companies covered in RealtyStocks, which may change from time to time, and will divulge such information upon request   Top InRealty Sponsors Inquire about our special advertising banner promotions! E-MAIL: stocks@inrealty.com Copyright ©2003, WebVisers Inc. All rights reserved .