3-5-04                                                                                           Vol. 7: No. 3 RealtyStocks' Observer If you're not receiving this free monthly e-newsletter, please register. Monthly Feature: CAPITAL IS FLOODING INTO COMMERCIAL REAL ESTATE A. Weak Fundamentals, Yet Capital is Flooding into Real Estate B. Anticipation of Job Growth, and Higher Rates C. Strong Dynamics for REITs and Real Estate Funds D. Equity REIT Performance E. Large Cap REIT Performance F. Mortgage REIT Performance G. Realty Corporations H. Real Estate Mutual Funds A. DESPITE WEAK FUNDAMENTALS, CAPITAL IS FLOODING COMMERCIAL REALTY According to numerous experts from across the country at "Real Estate 2004" in Los Angeles at the beginning of this week, the fundamental demand for commercial real estate, as reflected by soft rental rates and increasing vacancies, remains weak across most of the country. Of the major property types, the fundamentals for regional malls seem the best and apartments still seem the worst. With respect to offices, and to a lesser degree industrial properties, there is some optimism that if job growth improves this year, office and industrial markets will become healthier. Continued consumer spending is helping retail, but there seems to be a growing concern over the "Wal-Mart effect" as it relates to neighborhood shopping centers. Apparently, two supermarket anchors go out of business each time a Wal-Mart is built. This helps explain why the dynamics affecting food anchored centers are less desirable than those affecting malls. In order for apartments to rebound, besides stronger job growth, it may also take an interest rate hike, thus forcing more people to rent, thereby increasing occupancies. More than any other group, some experts project hotels will benefit the most from an increase in travel due to business growth as well as from baby boomers that have more time as they enter their retirement years. Regardless of the current fundamentals for real estate, the flow of funds (equity and debt) into real estate seems undaunted, both domestically and abroad. The transfer of capital into real estate capital could increase by 30% to 50% this year. In addition to a 59% increase in foreign investment last year, funds from this sector are also likely to increase. The strong performance of the stock market last year is actually helping more money come into real estate. Since this has caused the proportion of real estate in many institutional portfolios to decline, in order to achieve more desirable asset allocations, many managers simply need to acquire more real estate. Another reason for more money flowing into real estate is the strong performance that is still being achieved by opportunistic funds. These funds take advantage of the substantial difference in spreads between short-term borrowings and real estate "cap" (debt free yield) rates. They also maximize positive leverage, which has been producing stellar returns. With the overall demand for real estate continuously rising and the supply is static at best, real estate values are likely to continue to do well for the coming year. Other than fundamental factors, the key to commercial future real estate values is likely to be the amount of new supply and the degree to which rates will rise. With the prospects for strong job growth more temperate this year, rates could avoid any spikes for at least the next year. But even if a robust job market develops and rates jump, supply could become restrained or lag as the fundamentals of real estate rapidly improve. Consequently, many experts believe these supply-demand forces will be offsetting and, therefore, will not cause drastic price declines. Still, other authorities believe the prices on real estate could be nearing cyclical highs. This is because once spreads between cap rates and 10-year treasuries narrow and short term rates increase, the opportunistic money, which is driving up prices in many markets, should disappear.   Top B. ANTICIPATION OF JOB GROWTH AND HIGHER RATES It has been quite a while since there has been such certainty about the future direction of interest rates. Recent remarks from Alan Greenspan this past week fueled this viewpoint. The wild card in the equation, however, has been the long awaited increase in jobs. With a loss of over 2.4 million jobs in the past three years, and increasing population growth, many economists believe the U.S. economy needs to grow by over 200,000 jobs a month for a at least a few months before rates will increase. Even then, most economists expect 10-year Treasuries to increase no more than a full point by the end of the year (from 4% to 5%), and many expect the increase will only be half that. With a disappointing job growth for February reported at only 22,000, about 110,000 below forecasts, and the January job growth revised down below 100,000, there is no impetus for an immediate jump in rates. Some economists believe the harsh winter has slowed down job creation, but if job growth fails to materialize within the next few months, it will no doubt become a central issue in the coming political elections this fall. There is a lot at stake in a rebounding job market. It could not only help determine the Presidential race this year, but also the congressional balance of power. Another concern is that if job growth does not materialize, and a consensus develops that this is largely a result of off-shoring and the exportation of high paying jobs abroad, it may spawn more protectionism. Most economists believe that the greater the restraint upon trade, the more an economy suffers. Much needs to be taken into account by investors in the coming months. Although money still seems to be pouring into most mutual funds, especially real estate funds (see below), the broad performance of equity indices have been very weak this past month. Also, with the changes in demographics, many investment goals may start to shift from appreciation to yield. Consequently, if debt yields become more attractive again, it will place much more pressure on equities. Top C. STRONG DYNAMICS FOR REITs and REAL ESTATE MUTUAL FUNDS (REMFs) Money is pouring into real estate mutual funds that, in turn, mostly purchase shares in REITs. It is estimated that some 5 billion flowed into REMFs last year; some believe it may be more than twice this amount. There are some indications that even more than this amount will flow into REMFs in the coming year. In part, this is a continuation of the capital flow pouring into real estate, previously mentioned. Instead of directly acquiring real estate, a growing number of institutions are placing equity with managers that buy REITs. Further with, the aging baby boomers looking for more cash flow and less risk, REITs and REMFs can look very attractive. Even though the dividends from REITs do not qualify for the current tax reduction, they are tax-free if they remain in retirement accounts. It would seem that REITs would be active buyers of real estate. But REITs use longer-term money rates and therefore cannot compete with the opportunistic funds that buy real estate at lower overall yields and higher prices. Therefore, despite the higher stock prices of REITs, they have become net sellers, not buyers, and can actually have fewer assets, yet higher market caps. The net affect of this, and what REITs are reluctant to say, is that these high market caps are at the highest premiums over their asset values in years. Since REITs are not required to report the market value of their assets, this is not easily determined. Although some REITs are posting higher earnings, it is largely due to lower borrowing costs and expense reductions. This has caused the tenants in some REIT assets to be dissatisfied, which could cause more turnovers, which could also exacerbate the pressure on REIT earnings, especially in weaker markets. Hence, if the fundamentals of real estate markets do not improve, some REITs may have a more difficult time of posting good earnings this coming year and REIT dividend yields could decline both from appreciation and operational factors. As long as rates do not significantly rise appreciably, REITs should continue to hold their own, but some property groups, such as malls, may continue to do somewhat better. Even though apartment REITs may underachieve in the near term, ultimately, with improving job growth and higher interest rates, they should benefit.   Top D. EQUITY REIT PERFORMANCE Equity REITs posted a gain of 1.51% for February. The best monthly performers were Retail Factory Outlets and Retail Regional Malls, up 4.03% and 3.5%, respectively. Only one of the groups were negative for the month, Hotels, losing -2.51%. For YTD, the Equity REITs gained 5.58%. The best performing groups Year-To-Date (YTD) were Retail Regional Malls and Healthcare, gaining 14.2% and 10.49%. All the groups were in the positive for YTD. The worst performing YTD group was Mobile Home Parks, gain only a slight 0.06%. The best performing Equity REITs for February were Equity Residential Properties Trust (EQR) and LTC Properties, Inc. (LTC), gaining 36.6% and 15.4%, respectively. The worst monthly performers for the month were Amerivest Properties, Inc. (AMV) and Correctional Properties Trust (CPV), losing -10.9% and -10.8%, respectively. The best performing REIT YTD was Equity Residential Properties Trust, gaining 34.7%. The worst YTD performer was Tarragon Realty (TARR), losing 14.3%, respectively. (Please see Equity Gainers and Losers.).   Top E. LARGE CAP REIT PERFORMANCE Large Cap REITs had a slight gain of 1.4% for February, still just slightly behind the broad based REIT performance. The best large cap performer for February was Liberty Property Trust (LRY) followed by Simon Debartolo Group (SPG) gaining 9.6% and 4.7%, respectively. The worst performing large cap REIT for the month was Apartment Investment & Mng (AIV), falling -7.9%. The best YTD performer is Simon Debartolo Group (SPG) gaining 17.6%. The worst YTD performer is Apartment Investment & Mng (AIV) losing -6.1%. Please see Large Cap REITs.)   Top F. MORTGAGE REIT PERFORMANCE Lower interest rates continued to have a favorable affect on the mortgage sector, which posted a positive gain of 2.27% for February. This was slightly ahead of gains for Equity REITs. The best performing group for February was Residential Mortgages, gaining 6.13%. The best performers for February were Hanover Capital Management (HCM) and Anthracite Capital, Inc. (AHR), up 17.4% and 14.5%, respectively. The worst performer was Dynex Capital (DX) losing -13.3%, respectively. For YTD, the groups gained 6.44%. The best YTD performers were Hanover Capital Management (HCM) and Novastar Financial, Inc. (NFI), gaining 23.2% and 23%, respectively. The worst YTD was BRT Realty Trust (BRT), losing -20.6%. (Please see Mortgage Gainers and Losers.)   Top G. REALTY CORPORATIONS Realty and Housing Corporations had a price gain of 2.49% for February, slightly in front of both Equity REITs and Mortgage REITs. The best monthly industry performers were Mobile Home Manufacturing Co's gaining a whopping 20.2%, following by Builders with a gain of 9.4%. The worst monthly performer group was Tech & Net with a loss of -11.8%. The best stock performers for February were Champion Enterprises (CHB), up 59.4% and Liberty Homes, Inc. (LIBHA), up 33.8%. The worst monthly performers were Tut Systems, Inc. (TUTS) and Interstate General Co. (IGC), down -26.6% and -21.4%, respectively. For YTD, the group gained 7.33%. The best YTD performers were Lipid Sciences, Inc.(LIPD) and Bluegreen Corporation (BXG), gaining 101.4% and 67.3%. The worst YTD performer was Tut Systems, Inc. (TUTS), losing -17.2%, respectively. (Please see Realty Corp. Gainers and Losers.)   Top H. REAL ESTATE MUTUAL FUNDS (REMFs) The average total return for real estate funds for February was similar to the broader REIT performance of about 2.22%. The best performing monthly REMFs were CGM Realty and Morgan Stanley with outstanding returns of 9.26% to 7.98%. The best performing YTD REMFs were Morgan Stanley and Profunds Ultra with respective overall returns of 9.78% to 9.15% compared to the YTD average return for all funds of 6%. (Please see REMFs.)   Top Stock Changes. no changes. 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, and are calculated as of the end of each month. 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 ©2004, WebVisers Inc. All rights reserved .