Heitman Remains Bullish
On Beaten-Down REITs
The harder they fall, the bigger the potential rebound - at least for companies with savvy management teams and solid balance sheets.
That's how Tim Pire, managing director and portfolio manager at Heitman REIT fund, sees it as he hunts through the real estate sector for companies that stand to see the biggest gains as the economy rebounds.
Heitman's $170 million REIT fund delivered total returns of 36% in 2003 and 35% in 2004, according to Morningstar. That compares with total returns for equity REITs in general of 37% in 2003 and 20% in 2004, according to the National Association of Real Estate Investment Trusts.
So far in 2005, Heitman REIT returns are off 6.6%, while the benchmark is down 6.2%.
Pire's top picks are Vornado Realty Trust (VNO), Brookfield Properties Corp. (BPO) and Public Storage Inc. (PSA).
Two of the three - Vornado and Brookfield - have big holdings in New York, which was hit hard by falling rents and occupancies during the recession and have already started to rebound. Both were beaten down and stand to reap big rewards as the economy bounces back.
Pire said Vornado, a real estate investment trust, has an "outstanding" management team with an "opportunistic" investment strategy. He cited the company's recent surprise acquisition of a major stake in Sears Roebuck & Co. (S) and its strong development pipeline, which includes parcels of land in the hot Manhattan market, as areas that will help fuel the company's growth potential.
But Vornado is a complicated story that includes office, retail and mezzanine debt holdings, and the company never holds conference calls to discuss its financial results. "It's not an easy story," but its performance and track record have been strong, Pire said. Vornado offers a 4.2% dividend yield, and recently traded at $70.17, which is a 4.7% premium to the company's net asset value, or NAV, which Pire estimates at $67. He expects the company to post funds from operations growth of 5% to 6% in 2005 - with total returns coming in around 10%.
Brookfield Properties is a New York real estate operating company that owns high-profile office properties in downtown Manhattan, such as 1 World Financial Center, 2 WFC, 4 WFC and One Liberty Plaza. Long-term leases have helped insulate the company from turmoil in the Lower Manhattan office market following the Sept. 11, 2001, terrorist attacks and recession.
Like Vornado, Brookfield's management team has a solid track record for delivering attractive returns on its developments, and its balance sheet allows the company to act quickly on acquisition opportunities when they appear.
Brookfield's shares recently traded at $39.78, which represents a 47% premium to its NAV, which Pire estimates around $27. However, he said the shares warrant the premium, because the company is poised for annual FFO growth of at least 10% in both 2005 and 2006. With the 3% dividend yield added in, he's expecting total returns of 13% to 14% in 2005.
Pire's third pick - Public Storage - is a "leader in the self-storage industry," which is already showing signs of a rebound, he said. There's little new construction happening in the sector and occupancy has been climbing. The self-storage REIT holds shorter leases than office REITs, and will therefore allow the company to raise rents earlier and faster as the economy comes back.
Public Storage also enjoys a well-known brand name in the industry and a healthy development pipeline. The company's stock recently traded at $54.84, which is a 15.5% premium to the company's NAV, which Pire estimates at $47.50. However, he's predicting robust FFO growth for Public Storage of 15% to 16% in 2005. When its 3% dividend is factored into the mix, Pire expects 2005 total returns to approach 20%.
Pire is staying away from beaten-down office companies that have weaker balance sheets or operate in markets where job growth has been anemic. He cites Equity Office Properties Trust (EOP) as a company from which he'd currently shy away. The company was hit hard by the recession and won't generate enough cash flow to cover its dividend until 2007, he said.
"I think they have a good management team, but I just think they still have a tough road to go," Pire said.
He's also bearish on Corporate Office Properties Trust (OFC) and Archstone-Smith Trust (ASN), solely on valuation. He said Corporate Office owns office properties in Washington, with many tenants being government agencies. "It's a great name and great strategy - just a little bit pricey."
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