2-11-03                                                                                           Vol. 6: No. 2 RealtyStocks' Observer If you're not receiving this free monthly e-newsletter, please register. Monthly Feature: TERRORISM, A WAR WITH IRAQ & THE SECURITY OF REITs A. Terrorism & The Possible War with Iraq B. Yield, Safety and the Preservation of Capital C. The Security of REITs: More Safety in High Yields? D. Large Cap REIT Performance E. Equity REIT Performance F. Mortgage REIT Performance G. Realty Corporations H. Real Estate Mutual Funds A. TERRORISM & THE POSSIBLE WAR WITH IRAQ The federal government is warning us that we have become too complacent about the possibility of another domestic terrorist attack and that there is a high risk threat against us soon. In addition, the resolve of the U.S. to wage war against Iraq appears resolute. Although other countries are searching for ways to prevent this conflict and will place pressure upon the U.S. to accept alternatives, baring the exile of Saddam Hussein, such efforts will probably only delay action against Iraq. And, the longer the delays, the more difficult an attack against Iraq may become, not only logistically because of higher desert temperatures, but also due to increasing international and domestic sentiment against a war. The complexity and concerns over a war are mounting. First, the perception that the war with Iraq would be similar to the Gulf War may be misplaced. We are not liberating a country from an act of aggression, as in the Gulf War, but rather, we are viewed by some as the aggressor who is invading a country where a different type of resistance is likely. Street and bunker fighting, especially in the search for Saddam, could result in more casualties than in any U.S. conflict since Vietnam. And the potential use of chemical weapons by Iraq and the possible limited deployment of nuclear weapons by the U.S. could cause military and civilian casualties to be very high. Second, rising oil prices and the possible limited production of petroleum, especially if significant destruction occurs to the oil fields in Iraq, could stall an economic recovery not only in the U.S., but in other industrial nations as well. Third, the cost of war to the U.S. could be billions of dollars, adding to additional government increases proposed, which are already exorbitant. This could cause a financial burden to the U.S. that would increase interest rates jeopardizing an economic recovery and possibly reducing real estate values. Fourth, an Iraqi conflict could bring foreign relations with the U.S. to new lows resulting in more foreign investments leaving the U.S. which would also damage our economic prospects. Fifth, the risk of terrorism has heightened and the occurrence of such acts, domestically and abroad, especially as a reprisal for an attack on Iraq, would severely impact our economy, particularly in certain industries like airlines and lodging. Finally, there is the possibility that the U.S. could also become involved in other conflicts fairly soon, such as in North Korea.   Top A month or two ago, most economic forecasts indicated that the economy and financial markets would improve because corporate earnings would increase at a double digit clip and the GDP growth would be about 2.5%. Most economists and strategists felt, and many still believe, that a war with Iraq would be over quickly and would not have a serious effect on our economy. Another view was that a possible war is too speculative and should be excluded from any forecasts. In contrast, we do not believe the war is too hypothetical and, although we hope that a war can be averted, it is becoming more apparent to us that most forecasts have probably underestimated the probability and consequences of a war as described above. Another worrisome sign is are the corporate earnings for last quarter and revised forecasts for 2003 are indicating that the overall growth in corporate earnings growth will probably be less than expected. Therefore, until the Iraq situation is resolved and corporate earnings start to significantly improve, financial markets face more downside than upside potential in the near future, in our opinion. Of course, if a war with Iraq can be averted, and especially if Saddam Hussein steps down and seeks exile in another country, equity markets would leap. (Unfortunately, interest rates would also likely jump creating a less friendly environment for real estate.) Despite much banter and periodic hope of resolving the Iraqi situation, the result may only delay and possibly prolong an inevitable war. We believe Iraq is likely to play cat and mouse games as long as cheese is on the table, and if they do agree to terms acceptable to the U.S., it will only be as a last resort. Even with a fairly quick and successful war, we do not believe that concerns over Iraq will disappear because of the fragility of any new regime that would govern Iraq. Especially if Saddam survives, any new Iraqi leadership would be very tenuous, even if he was incarcerated or exiled. Another possibility that is also seldom discussed, is if Saddam disappears like Osama bin Ladden. Can a new Iraq be successfully transformed without knowing if Saddam is dead or alive? The reason for contemplating Iraq without Saddam, with or without a war, is that a resolution to the Iraq situation may not be over as quickly as most people think. Even if a war was quick and Saddam was no longer alive, martyrdom and an heir to his throne could pose significant problems. Unfortunately, there is the very real possibility that issues with Iraq could last much longer than anyone now contemplates.   Top B. YIELD, SAFETY and the PRESERVATION OF CAPITAL. As a result of prolonged and unnerving uncertainties, the mantra of an increasing number of investors is financial safety and yield. In addition, demographic and psychological shifts may occur that could reverse the focus on appreciation that drove investor actions throughout the last decade. As baby boomers age and retire, they need to be more certain of their income. They can no longer afford to take big risks for high appreciation that can result in big losses instead. However, as we discussed in past newsletters, the first decade of this new millennium is likely to be more similar to the seventies with a sideways motion that may also be highly volatile. And, without employment growth emanating from new technologies, we believe the resurrection of a strong economy is doubtful. The likelihood of riding a Tsunami of rising stock prices that occurred in the 1990's is therefore unlikely anytime soon. As a consequence, instruments with high yields like junk bonds and high yielding REITs may actually perform better than most other instruments over the next few years. Although real estate and REITs have provided a great haven for investors producing positive returns over the last three years, in comparison to significant losses with equity indices, this year is expected to be more challenging. What could be particularly alarming with respect to commercial real estate is the recent federal government warning that domestic terrorism may involve so called "soft" targets. This classification includes hotels, high rise apartments and office buildings. Although we do not want to overreact, the possibility of such an occurrence should not be completely ignored. Yet presently, very few if any fund managers or investors are assigning any probability to such occurrences among property type groups, cities or the REITs that have the greatest exposure. Although insurance coverage and costs for terrorism are also issues, as we discussed last month, what may become a new concern is the possible drop in both rental and investor demand for any property type or location that could become a likely target for terrorists.   Top C. THE SECURITY of REITs: More Safety In High Yields? During the first month of the new year, the REITs that have the highest yields, and reasonable security, performed better than those with lower yields. In particular, high yielding preferred REIT stocks were fairly flat during the last few months, while most other REIT stocks declined. In part, this appears due to investor's search for higher dividends which we discussed above. Should this trend play out, it may not be good news for the large cap REITs. As noted below, this group indicated a larger drop in price for January than the rest of the market. Explanations for this are threefold. Should a dividend tax exclusion in some form occur, but not apply to REITs, those REITs with high yields may become more attractive than the lower yields normally associated with large cap REITs. Second, since real estate market conditions are deteriorating, the outflow of funds among the mutual funds and institutions holding REITs, that normally consist of these larger issues, may increase. Also, many of the high yielding REITs are on the debt side or include non-core property types, such as health care or specialty properties, that may have market conditions that will provide better dividend support than the large cap REITs. Although real estate is sometimes viewed as an asset class that has little downside potential, this is not necessarily true. Just a few years ago, REIT prices declined in excess of 20%, and about a decade ago, many individual property prices dropped over 50%. Instead of overbuilding being the culprit in sabotaging real estate markets and values, this time it appears that the decline of jobs and the lack of employment growth is hurting most markets across all property types. The markets especially vulnerable include those that enjoyed the exuberance of high tech markets, for example office space in San Francisco. In the City by the Bay, rates are half of what they were a couple years ago and vacancies have increased from a few percent to around 20 percent. The possibility of an eminent office market rebound in this city is so unlikely that plans are underway to convert some major office buildings into apartments, in part or even in their entirety. With respect to apartments in general, an important issue is the loss of tenants who are purchasing homes. A major apartment REIT recently reported about one-third of its tenants moved into homes during just a year, which has caused much higher vacancies that will probably not decline significantly without new job formations. There are always some groups of REITs that overachieve or under perform their counterparts. Therefore, beware of REITs that 1) may have relatively lower yields, 2) are subject to market conditions that may cause significant drops in dividends and property values and 3) may be more prone to terrorist activity. Since the earnings of all but a couple REITs (measured by FFO) are expected to drop this year, it may be difficult for REITs to achieve their strong performance of the past three years. 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 within the next couple of weeks to Members.   Top D. LARGE CAP REIT PERFORMANCE For January, Large Cap REITs finished with a large monthly price decline of -4.3%. The best large cap performer for January was Kimco Realty Corporation (KIM) which had a slight gain of 2.5%, followed by AMB Property Corporation (AMB) which increased 1.1%. The worst performing large cap REITs for the month were Crescent Real Estate Equities (CEI), falling -9.9%, and Host Marriott Corporation (HMT), dropping -9.4%. (Please see Large Cap REITs.)   Top E. EQUITY REIT PERFORMANCE Although Equity REITS began the new year with a monthly loss of -2.0% in January, the broader REIT market significantly outperformed the large cap issues. The best performing group for January was Retail Centers (up 0.37%), and the only group to show a positive gain this month. The worst performing groups for January were HealthCare (down -6.94%), followed by Self Storage (down -4.27%). The best performing stocks for January were Prime Group Realty Trust (PGE) and Tarragon Realty (TARR), gaining 16.9% and 14%, respectively. The worst monthly performers were Omega HealthCare Investors Inc. (OHI) and Meristar Hospitality Corp (MHX), losing -26.7% and -13.6%, respectively. (Please see Equity Gainers and Losers.).   Top F. MORTGAGE REIT PERFORMANCE This sector finished January with a moderate loss of -1.69%. The best performing group for January was Residential & Commercial Mortgage, gaining 2.7%, followed by Residential Mortgage with a gain of 0.86%. The best performers for January were Novastar Financial, Inc. (NFI) and Dynex Capital (DX), up 12.6% and 10.1%, respectively. The worst performers were Capstead Mortgage Corp. (CMO) and Capital Trust (CT), losing -47.9% and -11.9%, respectively. (Please see Mortgage Gainers and Losers.)   Top G. REALTY CORPORATIONS Startingoff the new year on a positive note, Realty and Housing Corporations had a price increase of 0.13% in January. The best monthly performer was OnSite Tech with a gain of 4.5%. The worst monthly performer was Lodging with a drop of -6.22%. The best performers for January were American Tower (AMT), up 43.9% and Moore Corporation (MCL), up 34.2%. The worst monthly performers were US Realtel Inc. (USRTE.OB) and Cavalier Homes, Inc. (CAV), down -31% and -21.6%, respectively. (Please see Realty Corp. Gainers and Losers.)   Top H. REAL ESTATE MUTUAL FUNDS (REMFs) The average return for 138 REMFs for January was -3.55%, which slightly outperformed the large caps, but under performed the overall price performance of REITs. The best REMFs in January included some of the top performing funds from last year, Alpine International, Kensington Select Income and Alpine U.S. with respective overall returns of 1.15%, 0.5% and -.08%. Since most REMFs hold large cap issues and often avoid high yielding issues, REMFs may have a difficult time in beating the broader REIT market again this coming year. (Please see REMFs.)   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 .