6-6-05                                                                                           Vol. 8: No. 3 RealtyStocks' Observer If you're not receiving this free monthly e-newsletter, please register. Monthly Feature: REITs GAIN On Lower Rates and a "Goldilocks" Economic Perspective A. A Goldilocks Economy Favoring Real Estate B. Mixed Economic Signals & Modest Growth C. REIT's Bounce Back D. Equity REIT Performance E. Large Cap REIT Performance F. Mortgage REIT Performance G. Realty Corporations H. Real Estate Mutual Funds (REMFs) A. A GOLDILOCKS ECONOMY FAVORS REAL ESTATE Housing sales were hot again last month throughout most of the country, prompting even more speculation and comparison of a prospective real estate bubble burst to the devastating dot com bust. Recently, the Federal Reserve has also noted some concerns about real estate, but in a more gentle comparative way. They forsee some potential excess froth, as opposed to a popping bubble, limited to only some housing markets. In the late 1990's, a few economists employed the "Goldilocks Economy" theory to justify high dot com prices, extending the reference to porridge as things were not too cold or too hot - but just right. For almost two years, we have maintained that for a strong real estate market to continue, the economy must have a "sweet spot" where inflation is low, economic growth is modest and interest rates are low and static. Presently, we are enjoying just that. The big question that remains, is how long can such an economic sweet spot, or Goldilocks Economy, last? Historically, if you compare cycles, the last great stock bull market lasted around a decade, through the 1990's. The run-up in some real estate markets is viewed as beginning with the dot com demise in 2000, or has lasted about 5-years so far; though depending upon the geographic area, this period can be longer or shorter. In the past, real estate cycles were often viewed as about 5- to 7-year periods. Therefore, from a historical perspective, it appears we should be arriving at the end of a strong housing cycle relatively soon. However, we do not believe the end of the cycle will be in sight until long term rates rise significantly. And, unless (10-year Treasury) rates rise both quickly and substantially, (e.g. over a full point in six months and over two points in a year), the end of this cycle will probably not be obvious. However, some housing markets will undoubtedly be affected more than others. The danger that a collapse in real estate markets poses to the economy is certainly known to both investors and economists, and especially to the Federal Reserve Governors. Recently, there has been some effort to limit the speculative nature of residential markets. The significant increase in short term rates alone, with the prime rate rising from 4% to 6% in about a year, for example, should eventually help curtail some demand by increasing housing costs. Stricter underwriting standards are also beginning to occur, especially for individuals who are purchasing more than 3 or 4 homes. We believe regulators will not necessarily be able to avoid an eventual real estate pull back in certain markets. However, they should be able to help prevent a drastic decline within a short period of time by further implementing stricter underwriting standards - thereby reducing the probability of a real estate bubble-bursting scenario. Further, because real estate does not quickly "mark to market" , i.e., transaction times of home sales are in months instead of seconds as with stocks, a decline in real estate prices will require a much longer process than with the dot com bust. Comparitively, unlike some dot com stocks that made no economic sense, most real estate has economic value, making any fall in prices much less severe than during the dot com bust. Even so, for those that have minimal equity in their homes or real estate investment (e.g. 10% or less), even relatively small real estate declines will evaporate that equity and could prove to be a bust to many.   Top B. MIXED ECONOMIC SIGNALS & MODEST GROWTH In the past year or two, it seems that economic factors appear to often be equally divided between those that are positive and negative. Further, many economic factors seem to change within a quarter and lack a decisive trend. For example, the on and off concern about inflation has abided recently with a core inflation increase of only 0.1% last month. Oil prices have dropped more than 10% in the last three months, but with the onset of summer, are again on the rise. Long term interest rates and 30-year fixed rate mortgages have dropped about half a point (50 basis points) in the past couple months, negating the half-point rise three months prior. Consumer sentiment shows some recent declines, however retail sales have recently improved. The GDP for the quarter came in slightly higher than expected, (in the mid 3% range), but economists have dropped their GDP estimates for the next quarter by 0.2%. Despite record setting trade deficits, it dropped last month. Employment growth was much weaker than expected last month, but stronger the month before. The stronger than expected growth in Labor Costs recently raised an inflationary concern, but are somewhat offset by productivity gains. Perhaps the most confusing mixed signal to investors and analysts is the recent decline in the 10-year Treasury below 4%, matching a 14-month low, while the stock market edges up. Normally such a rate decline would indicate that the economy is slowing, or that economic problems lie ahead. So why is the stock market headed up? It seems as though stock investors are wearing different glasses and viewing the economy differently than bond investors. One explanation for this divergence is that some major hedge funds may have incorrectly made big bets on rising treasury and bond prices and are trying to cover their positions, which is driving down rates. Yet, if some large hedge funds fail, this could have a negative impact upon equities. As noted in our last newsletter, concern over China's surging textile shipments, undervalued currency and particularly trademark and copyright piracy, are increasing domestic and international tensions. This also increases the potential for trade wars. The U.S. and other major countries appear to be getting tougher on these issues and unless China is willing to make some concessions soon, this could present a more serious problem, with negative economic implications. Another International issue that could weaken European growth is the recent rejection of the EU in France and the Netherlands. Though the most worrisome issues appear to be increasing oil prices and trade deficits, as long as they maintain control, it may still be possible for the Goldilocks Economy to continue for some time causing real estate to benefit, albeit more slowly.   Top C. REITs BOUNCE BACK After a negative first quarter price drop of -8.9%, REITs bounced back with consecutive monthly gains of over 3% and are less than -1.44% down for the year. Over the past couple of months, REITs have benefited from declining rates and a growing "Goldilocks" sentiment, as explained above. In addition, the prospects of more consolidation, most recently sparked by the multi-billion dollar acquisition announcements of Gables Residential (GBP) by ING Clarion and Catellus (CDX) by ProLogis (PLD), should help fuel the desirability for REITs in the near term. Already this year, the acquisition activity is more than twice than last year's. However, any increases in rates for 5-years and beyond, are likely to reverse REITs recent climb.   Top D. EQUITY REIT PERFORMANCE For April and May, Equity REITs posted respective monthly gains of 3.85% and 3.18%. In May, all groups had gains and only two groups posted loses the month before. The best performer in April was Regional Malls with a surge of 10.46% and the top group last month was Hotels with a gain of 5.5%. The laggard for two consecutive months were Mobile Home Parks with a drop of -2.71% in April and a slight gain of only 0.82% in May. For the year, the best performer is Self Storage with a gain of 5.45%, Regional Malls with a gain of 5.07% and Diversified with a gain of 1.83%. Year-to-date, all other groups are still negative. (Please see Equity Gainers and Losers.).   Top E. LARGE CAP REIT PERFORMANCE Large Caps posted gains of 4.6% for April and 3.4% for May. Still, the Large Caps have lost -2.8% for the year. Only a couple of the two dozen issues were negative in each of the last two months. The best performer was General Growth Properties with a gain of 12.6% in April and St. Joe with a rise of 10% in May. The worst performers were iStar Financial with a drop of -3.3% in April and Apartment Investment (AIV) with a drop of -2%.7% last month. For the year, only a half dozen issues are positive, with St. Joe ranking the best with a gain of 11.7% and Duke Realty showing the worst performance with a loss of -10.7%. (Please see Large Cap REITs.)   Top F. MORTGAGE REIT PERFORMANCE Though this sector under performed Equity REITS with gains of only 0.8% and 3.73% for April and May, respectively, it shows a slightly better performance for the year with a loss of only -0.14%. Commercial Mortgages performed the best in May, but were the worst in this sector for April. (Please see Mortgage Gainers and Losers.)   Top G. REALTY CORPORATIONS Realty Co's. stumbled behind REITs in April, with a disappointing loss of -2.25%, but outperformed REITs last month with a gain of 5.97%. For the year, Realty Co.s are up 5.21% and are also ahead of REITs YTD. Most sectors were negative in April, with Timberland having the worst performance with a drop of -6% and Property Services doing the best with a gain of 2.3% For May, Home Builders made a strong showing by leaping 12%, while Mobile Home Manufacturing was the only negative group, falling -0.6%. (Please see Realty Corp. Gainers and Losers.)   Top H. REAL ESTATE MUTUAL FUNDS (REMFs) The average total return for real estate funds for May was 3.74%, including dividends, and was under the broader index that excluded dividends. The best performer was Alpine U.S. with an overall return of 10.11%. Since Home Builders outperformed all REITs this past month by a wide margin, it would appear that most REMFs have cycled out of this sector and are probably over weighted in Offices, which also had a lackluster performance last month. Out of over 200 REMFs, the total return of the average REMF is 0.77%. When dividends are excluded, we believe REMFs have a very similar performance to the broad-based REIT performance. YTD, Alpine U.S. is also the best performer with a gain of 11.29%. (Please see REMFs.)   Top Stock Changes. The following stocks have been deleted from our coverage either due to a low stock price under our threshold or a change in their lisitng status: LNR Property Corp.(LNR), Amerihost Properties Inc.(HOT), Phillips Int'l Realty (PHIR.PK), Kranzco Realty Trust (KRT), Summit Properties, Inc., Restaurant Properties (USV) and Cornerstone Realty Income Trust (TCR). The following stock symbols have changed: (SMT)Supertel Hospitality (HUMP) has changed to (SPPR) and Modtech Holdings (MODT) changed to (MODTE). 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 .