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A Firm Footing At Last


Investing in 1994: REAL ESTATE

A FIRM FOOTING AT LAST

After its rapid, fiery descent in the late 1980s and early 1990s, the real estate business almost seemed ready to close down for good. Fortunately, though, the industry is displaying strong signs of life. No one expects a dramatic takeoff, but for the first time in years, many real estate markets are stabilizing or even enjoying a recovery. The housing market is positively healthy, with falling interest rates fueling a climb in housing starts, sales, and even pricing in some areas.

There's good news in commercial real estate as well, with vacancies in many office buildings tapering off. And Wall Street is providing more ways than ever to invest in real estate and get some of the juiciest yields around. Investors just need to keep in mind that above-average rewards often involve above-average risks.

TENANTS' SMARTS. The biggest real estate returns in 1993 went to bottom-fishers. By snapping up properties in depressed sectors and either reselling them or packaging them into securities for resale, such "vulture investors" benefited handsomely. While few individuals are able to play the bottom-fishing game, investors that band together can. In 1990, Waad Nadhir and two other investors formed BOSC Group, based in Birmingham, Mich., to "use our very good skills learned as tenants searching for prime real estate for our stores...to buy quality properties that were, for us, at affordable prices," says Nadhir. Calling on their retail backgrounds in video and convenience stores and supermarkets, the investors have bought three shopping centers so far, in Detroit, Texas, and California. After rejuvenating the centers, they anticipate a return of at least 20% after a five-year period. But competition for properties is starting to drive up values, they say.

Multifamily housing in the Southwest was the most sought-after asset among value-hunters last year, says Paul C.

Reilly, KPMG Peat Marwick's national director of real estate consulting. A bottoming out of apartment supply, the brighter economic picture, and renewal of a tax credit for building and renovating low-income housing were behind much of the interest. And while the home runs may be gone, Reilly feels that "for people who want a constant yield...multifamily housing is still a good investment vehicle."

Many bottom-fishers are now casting their hungry eyes elsewhere. "Office buildings and hotels are the least favored class of real estate, but a lot of people are sniffing around there," says John Stanfill, director of investment properties for CB Commercial Real Estate Group. He expects more interest in suburban office centers than in the business districts of major cities but notes that his firm recently bought two office buildings in such districts. Investing along with the pension funds of major corporations, CB Commercial bought one office building in Detroit's business district on "very favorable terms," says Stanfill. "It seems on the surface a contrarian move, but...it's got a strategic location, quality tenants, it's well-leased...and we agreed that it was a sane opportunity." Stanfill, who plans to fix up the property and sell to a more passive investor in three to five years, expects an annual return in the high teens.

For those who would prefer investments that are more liquid, there are real estate investment trusts (REITs)--indeed, more of them than ever before. As of Nov. 30, close to $7.5 billion had been raised in initial public offerings of REITs and $3.3 billion more in secondary equity offerings. REITs are created by developers, usually because they are strapped for cash and unable to find lenders. To stay afloat, they package their properties into a REIT that can be sold through a public stock offering. Investors in the 178 publicly traded REITs available can get yields that top 9%, although 6% to 7% is more common.

HITTING THE ROAD. All REITs are not created equal. While there are quality REITs with good properties and strong management, 1993's "rush to REIT," fueled by Wall Street's lust for fees and developer's desperation for capital, has produced REITs of questionable quality. Concerns over the growth prospects of such stocks has hurt their prices in recent months. Granted, total return for 1993 through Nov. 30 was a robust 19.86%, according to an index of equity REITs tracked by the National Association of Real Estate Trusts in Washington, D.C. But the index dipped 1.91% in October and another 5.42% in November. December is expected to be flat or down slightly.

Some portfolio managers see the correction as a warning shot to REIT issuers that will create buying opportunities. "That these deals will have to be clean and come out at competitive yields is nothing but terrific news for portfolio managers," says Dean Sotter, a portfolio manager for the $110 million Chicago-based PRA Real Estate Fund. PRA has concentrated on economically sensitive apartments and retail properties but now plans to focus on discount centers such as Michigan-based Horizon Outlet Centers. PRA recently bought Chicago-based CenterPoint Properties Corp., a REIT that concentrates on industrial properties and yields about 8.25%. Sotter likes its focus on one specific property type--factory outlets--and the high level of insider ownership.

Another REIT bull is Barry Greenfield, portfolio manager of Fidelity's $450 million Real Estate Fund. Greenfield expects investors to start focusing more on industrial and hotel REITs. He likes the RFS Hotel Investors Inc. offering, which yields about 8.5%. Beyond REIT stocks, he likes Host Marriott Corp. and La Quinta Inns Inc. A more speculative buy he is considering is Prime Motor Inns. His reasoning: "As the economy gets better, people are willing to travel more. And once occupancy gets past a certain mark, any improvement at all drops to the bottom line."

Some of the best news in real estate in 1993 was in the housing market, whose solid gains were fueled by falling mortgage rates. The rate on 30-year fixed mortgages slid in mid-October to 6.83%, close to a 28-year low. At the end of November, the average rate was 7.4%, compared with 8.21% a year earlier, and in mid-December, rates were hovering near 7.25%. The prolonged drop in rates in 1993 led to a record year in mortgage originations, says Paul S. Havemann, a vice-president with mortgage research firm HSH Associates in Butler, N.J. Low rates have sparked a massive wave of refinancings, with some homeowners refinancing two or three times.

Improved affordability drew many first-time buyers over the threshold. About 45% mf home buyers last year were first-timers, compared with the usual one-third. John Tuccillo, economist for the Chicago-based National Association of Realtors, notes that "as the economy has shifted into a lower-inflation mode, price growth in housing has settled down as well." Long term, he expects housing prices to rise at the rate of inflation plus a percentage point, or at about 4% in 1994.

Richard J. Loughlin, president of Century 21 Real Estate Corp., predicts that if home prices remain stable, interest rates stay low, and first-time buyers keep buying, 1994 could be the best year in residential real estate since the late 1970s. The hottest markets are those where employment is rising or expected to rise: from the south-central U.S., starting with Texas, to the Rocky Mountains, up through Colorado and into Montana. Utah and Colorado even face a shortage of homes for sale. A few hundred miles away, in great contrast, is Southern California, a market that Loughlin thinks has bottomed out, though many others believe it has further to fall. And in the Northeast, a slow recovery has already begun.

Homebuilders have responded to the demand by getting out the hammers and nails. Single-family housing starts in 1993 reached about 1.1 million, compared with 1992's 1.04 million. Multifamily housing starts slid slightly, to 156,000, but are projected to rise to near 200,000 in 1994 as demand starts to outstrip supply. Some say it may be too late to buy building stocks. But Merrill Lynch building industry analyst Jonathan Goldfarb still sees opportunities. "In every postwar upcycle, prices of housing-sensitive stocks have never peaked until about the same time as housing starts," he says. And he doesn't think starts will peak until 1995 or 1996. A few of Goldfarb's picks: Owens Corning Fiberglass, the largest producer of fiberglass and residential roofing shingles in the U.S.; ABT Building Products Corp., which produces siding and specialized plastic building components; and homebuilders Lennar and Centex.

After years of comparisons to train wrecks and other disasters, the real estate market may merit a rosier vocabulary. To say real estate has recovered is stretching things. Let's just say that the real estate industry is now on firmer ground, which compared with the past few years, sounds awfully good.Suzanne Woolley in New York


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