4-1-05                                                                                           Vol. 8: No. 2 RealtyStocks' Observer If you're not receiving this free monthly e-newsletter, please register. Monthly Feature: Global Pressures Are Affecting Both Equity Markets and Real Estate A. Equities and Real Estate Face Increasing Global Pressures B. Residential & Commercial Real Estate Markets Could be Peaking C. Not All Property Types Are Treated Equally D. Equity REIT Performance E. Large Cap REIT Performance F. Mortgage REIT Performance G. Realty Corporations H. Real Estate Mutual Funds (REMFs) A. EQUITIES FACE INCREASING GLOBAL PRESSURES Increasing mergers have helped equities pull out of their stumble at the beginning of the year, but to sustain any momentum, the market needs more. The gain of 243,000 jobs in February was favorable, but faltered again in March with a gain of only 110,000 jobs, just one-half of the forecast. Still the GDP is posting respectable growth of around 4% and the economy is poised for continued growth. However, oil and gas prices are near their all time highs, which is increasing costs. This factor, along with a record setting national deficit, makes the continued rise in the discount rate likely and are big contributors to the increased fear of inflation. This is also causing upward pressure on longer term rates, pushing the 10-year Treasury up about a half a point (50 bp's) in the past quarter. Though it was thought the declining dollar would help increase our exports, it is making commodities more expensive and a growing number of executives believe the cheaper dollar is actually hurting, rather than helping, their businesses. Further, with the Chinese Yuan pegged to the dollar, the price of goods from that country have not increased, which could have slowed their imports. Instead, China is rapidly expanding into importing other types of goods, (most recently apparel), which has widened the trade imbalance between China & U.S. trade has widened. Some economists claim that the real culprit is not the major importing countries, but the U.S. consumer who seems to have an unabated appetite for inexpensive goods made abroad. They claim the U.S. consumer needs to have a greater propensity for savings, more typical of other industrialized countries. However, baring a much higher increase in the price of imports, or possibly higher costs associated with rising oil prices, it is unlikely that the behavior of the U.S. consumer will soon change. In addition to the dim prospects of changing consumer behavior to help curb our growing national deficit, one particular issue that is becoming more worrisome to many economists is a higher probability, however likely, that a continued declining dollar will cause a flight of foreign investors from our debt and equity markets. During the past several months, many International investors are under allocating funds for U.S. equities and avoiding new investments in the U.S. However, should this excellerate so that major Internationl groups pull-out of U.S. equities, it could cause the dollar to plummet and interest rates to raise rapidly, thereby sending us into another recession. Increasing our interest rates could help mitigate this from occurring, and is another reason why the Federal Reserve Board will likely continue to raise the discount rate this year. Further, if inflation concerns persist, the Fed may bump this rate by more than a quarter of a point during one of their regularly scheduled meetings. Of course, the draw back to these rate hikes, though it may strengthen the U.S. Dollar, is that it could dampen economic growth. Some economists feel that such a prospect will help keep longer term rates from increasing much higher this year and result in further narrowing of the yield curve. Hence, mortgage rates could continue to remain fairly affordable, which would prevent major disruptions in the housing and commercial real estate markets.   Top B. RESIDENTIAL AND COMMERCIAL REAL ESTATE MARKETS COULD BE PEAKING For the last few years, the generation low level of interest rates has pushed both residential and commercial real estate (CRE) prices to all time highs in much of the country, particularly in most coastal cities where demand has been strongest and supply is restrained. The foreign demand for U.S. real estate, now also including housing in certain resort oriented markets, has also grown. This may seem strange given that foreigners would be placing money into this country that seems likely to devaluate. But the devaluation of the dollar has made the price of our real estate seem like bargains to some foreigners; especially in contrast to the real estate values in their countries. It is difficult to quantify the influence of foreign demand upon our domestic real estate markets, but it has undoubtedly helped contribute to higher prices. Though the investor demand for real estate is strong, we are beginning to be concerned about the rental and user demand to occupy space, which ultimately will affect investor demand. Because of the displacement of jobs abroad, especially in some areas of our country, it could ultimately affect the demand for space. For example, it is making manufacturing buildings less desirable in parts of the Southeast and Mid-West and office space for technology and call centers less desirable in certain markets. Where this is creating higher unemployment, it can negatively affect retail real estate, since there is less spending money available, and it can restrain home values. However, we believe there may be a double whammy that could impact commercial real estate consisting not only of our loss of jobs abroad, but a change in the way we use of properties. The growing propensity for workers to work more frequently from home, along with multiple workers sharing the same office at different time intervals and higher worker productivity through technology, could eventually have a more material effect upon the demand of office space. Granted, relatively limited construction development has kept the supply of real estate largely in check over the last couple of decades. However, now that the domestic work force that is being displaced is aging, future supply needs for new space will lessen. Another factor that we believe is often not adequately considered by commercial property investors is the amount of obsolescence inherent in buildings that are over a couple decades old. For instance, these older buildings often have inadequate parking facilities, less desirable floor plans, low ceiling heights, life-safety-security system issues, and/or are non-ADA compliant Therefore, many investment properties require a much greater amount of renovation than is contemplated. The issues could therefore warrant a higher risk premium than is currently reflected by the current level of capitalization rates applicable to commercial properties, now often under 7% (which translates to a stock PE ratio of a little over 14). These unprecedented low "cap" rates seem to provide little room for error when forecasting the operations of a property. Also, the current level of cap rates basically assume that we will continue to have low mortgage rates. We are therefore becoming increasingly concerned that should this fundamental demand for the use of real estate decline and rates rise, the pricing for commercial real estate will materially take a change for the worse. As we said before, the value of real estate in REITs is predicated upon a delicate balance of economic growth and stable mortgage rates. But historically, real estate is often prone to cycles over several years. Since have been on an upward cycle in many markets since the mid 1990's, we could be due for a downward turn in this cycle more quickly than has been anticipated.   Top C. NOT ALL PROPERTY TYPES ARE EQUAL Residential and commercial real estate are affected mostly by different factors. Yet, a factor that can affect both is the sudden increase in financing costs. What makes residential and commercial real estate march to different beats, however, is the dichotomy of commercial real estate which meets different needs through different property types. Further, some commercial property types are likely to be impacted more than others. For example, though most office markets show some firming, we do have some fundamental concerns over this property class. This is primarily because job growth is not as robust as in past recoveries, largely due to: strong productivity gains from the benefits of technology, lower space requirements by many companies, more flexible hours with people working at home and global outsourcing. Consequently, the improvement in office markets may not be as strong as envisioned. Industrial properties benefit from the need for distribution centers, in particular involving goods from abroad, but loose out with those facilities geared to manufacturing. Lodging and travel have continued to improve due to not only the economy, but fewer concerns over terrorist threats. However, technology may also decrease the need for business travel and higher oil prices are making transportation costs more expensive. (Airlines have already raised their fares four times in a few weeks.) Apartment REITs, as we've noted previously, have been hurt by a strong and affordable housing market. However, if this changes, apartments should see their occupancies and rents improve. Retail occupancies and rents have also improved, but it is interesting to note a continued increase in deliveries from Internet orders. Also, retail consumption is likely to wane with the higher cost of goods and transportation costs, increasing interest rates on consumer debt, and possibly slower gains in home prices and stocks. Despite the noted concerns for demand for the use of commercial space, construction of such space in the last couple of decades, generally has been limited in many markets. In the past, overbuilding was the culprit for depressed real estate markets, especially for office properties. Though the supply of new space was eventually picked up by the increasing user demand, aging baby boomers and other factors as noted can change the need for new supply. With respect to housing, there is also a growing concern that investor speculation, estimated to be about 20% of all home purchases, could also make certain residential markets very vulnerable. With the increase in short term rates, interest only mortgages have been on the rise. Thus, cheap money for residential real estate is starting to dry up. More restraints are also expected upon owners of more than a few homes. As a result, there is some fear that as the costs for home speculators increase, they become more financially stretched and will unload their holdings thereby increasing the supply of properties on the market. Consequently, an over supply of housing, along with higher mortgage costs, are likely to weaken values. Recent housing studies indicate that certain metro markets, especially those on the coasts and that have been performing strongly, have a 35% to 50% probability of declining in the next couple of years. Already, some of the hottest residential markets, like Las Vegas, are starting off this year cool, with a forecasted gain for the year in the single digits. Needless to say, these events do not bode particularly well for home builders, whose stocks have slipped this year, and especially for housing speculators.   Top D. EQUITY REIT PERFORMANCE Equity REITs dropped -6.31% in January, were fairly flat in February and declined -2.38% in March. After the first quarter of the year, the price of Equity REITs has declined -8.26%. All property type groups are negative for the quarter, but two groups had gains in March, MH Parks and Self-Storage, which posted respective price increases of 3.67% and 2.55%. These are also the best performers for the quarter with respective losses of only -1.97% and -2.6%. The property group performing the worst for March was Industrial, off -4.67%, after performing the best the month before, with a gain of 3.62%. For the quarter, the worst performers, all posting double digit declines, were Retail Factory Outlets, Retail Malls and Health Care with respective drops of -16.86%, -13.41% and -11.25%. In March, the best indiviual performer was Transcontinental Realty (TCI), up 22.3%, which also performed the best for the quarter with a 34% gain. The worst individual performer in March was Jameson Inns (JAMS), down -19.2%. but the worst stock for the quarter was Novastar Financial (NFI) down -27.3%. ( For the quarter, the (Please see Equity Gainers and Losers.).   Top E. LARGE CAP REIT PERFORMANCE Large Caps also faltered in the first quarter with a drop of -5.3%, better than the broader index. Though Large Caps were down -7.1% in January, they rebounded 1.9% in February before lossing a similar amount in March. The best large cap performer for March was Public Storage, gaining 4.4%. The month before, Equity Office had the best gain with 7.3% and also had the best (and only) gain for the quarter of 3.6%. The worst performer for March with a drop of -6.9% was Health Care Property (HCP) and the laggard for the quarter, with the only double digit loss, was Archstone with a loss of -11.7% (Please see Large Cap REITs.)   Top F. MORTGAGE REIT PERFORMANCE After under performing its equity siblings last year, this sector declined only -4.14% for the quarter. However, Mortgage REITs underperformed Equity REITs in March with a loss of -2.91%. For March, Resdiential Mortgages was the worst performing group with a drop of -3.27%. However, the mix of Residential-Commercial Mortages was the worst performer in the quarter, declining -10.22&. The best perfrorming group for the month and quarter is Commercial Mortgages with respective losses of only -2.37% and -0.42%. The best performing stock Morgage RETI for March was Am. Resd'l (AMNT) up 2.9%, but for the quarter, CRIIMI Mae posted the top gain of 24.8%. The worst perfroming stock for March was BRT Realty declining -13.5% and the worst performer for the quarter was Novastar with a drop of -27.3%. (Please see Mortgage Gainers and Losers.)   Top G. REALTY CORPORATIONS Realty Co's. have outperformed REITS in 2003 and 2004 with respective gains of 52.13% and 38.61%, and continued to perform well with a gain of 1.62% in January and 4.59% in Febraury. Though this sector sustained a loss of -4.23% in March, it still has a positve gain of 2.65% for the quarter. For March, Tech & Net was the best group with a gain of 2.3%. The worst groups were Home Builders and Constr. & Engr, down -13.8% and -10.4%, respectively. For the quarter, Lodging has outperformed all other groups with a whopping gain of 34.63% and Home Builders has been the worst, off -8.3%. The best performing Realty Co. for March was Hearland Parners (HTL)up 9.7% and the leading gainer for the quarter is Pope Resources (POPEZ) up 46.4%. The worst performer for the month was Bluegreen Corp. (BXG) down -35.2%, after posting lower earnings than expected, and the bottom stock for the quarter was TUT Systems (TUTS) losing -40%. (Please see Realty Corp. Gainers and Losers.)   Top H. REAL ESTATE MUTUAL FUNDS (REMFs) The average total return for real estate funds for March was -2.66% compared to the overall REIT performance of -2.48%. For the quarter, REMFs have lost -6.65% compared to the broader REIT market decline of -7.54%. However, since REMFs include dividends compared to RealtyStocks coverage that only includes price changes, the return of REMFs is similar to the broader REIT for the quarter, but has underperformed this past month. We expected that declines from certain Realty Co. groups, especially Home Builders, would drag down REMF performance for the year compared to the broader market. Though this may be starting, REMFs may also be thinning their positions in this group faster than we expected. Out of 200 REMFs, none were positive for March and the best performer was Third Avenue witha decline of -0.94%. For the quarter, only 4 REMFs were positive with the top performers including Alpine U.S. and Alpine International with respective gains of 3.23% and 2.22%. (Please see REMFs.)   Top Stock Changes. None. Note: In reporting group percentage changes, if a stock is under $2 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 .