From the July 2002 issue of Investment Advisor • Subscribe!

The New Real Deal

Alpine Realty Income & Growth is a REIT fund with

With their high yields and low correlation to equity indexes, real estate investment trusts have maintained a certain conservative attractiveness in today's depressed stock market. So what happens when a REIT fund invests in companies that are not traditional real estate plays? Just ask Robert Gadsden and Sam Lieber, lead portfolio manager and founder, respectively, of the Alpine Realty Income & Growth Fund.

Alpine's investment strategy has won the fund five-star ratings from both Standard & Poor's and Morningstar. Gadsden and Lieber's strategy is based on picking companies that are expected to grow over time and whose dividends are covered by operating cash flow. They don't invest in the technology or automobile sectors, but do include companies that derive at least 50% of their earnings from or hold at least 50% of their assets in, real estate. "We will invest in a company that is essentially a real estate company," Lieber says, "even though that may not be its primary business."

For example, a few years ago Alpine invested in Alexander's, a department store chain based in midtown Manhattan. "It's a REIT fund now, but it didn't used to be," says Lieber. "As a retailer it was struggling and subsequently went bankrupt, but as a real estate company it performed very well."

With Gadsden overseeing things on a day-to-day basis, and co-manager Lieber monitoring Alpine's other funds, both men contribute to the investment decisions regarding Alpine Realty Income & Growth. "We look at everything a company has to offer," explains Gadsden. "Its management team, its balance sheet--we even look at its regional market before we make a decision to include it [in our fund] or not."

Gadsden and Lieber have seen the worst of real estate times evolve into the coalescing REIT market of today. Those experiences taught them that sector-specific investments don't work, and that there is no substitute for fundamental research. "We do not predetermine specific sector allocations," says Lieber. "We are more organic than that."

We recently spoke with Gadsden and Lieber in their New York office about consumer spending, outlet malls, how adding a non-diversified fund to your client's portfolio can be a good thing, and the cadence REITs have followed over the last 30 years.

How does consumer spending in your areas of interest affect this fund? Gadsden: Our investments are broken down by property, but they are out of alignment with our benchmark [the Morgan Stanley REIT Index] weightings. We try to determine which property types we think are going to perform the best before investing in them. Currently, we are heavy in lodging, retail, and the broad category of office and industrial properties, which includes warehouses. We also have a fair amount of investments in mortgage finance companies and health care. How consumer spending affects those investments has, I think, surprised most economists. Consumers have been the strongest part of the economy over the last 12 months, especially in housing. Because the consumer is taking advantage of a low-interest environment to refinance and buy new homes, apartment companies have not been doing as well. So our investments in apartments are smaller than in mortgage and homebuilding companies.

Lieber: This consumer-to-market relationship indicates a positive direction for the economy in general. Lower interest rates are allowing people to refinance and purchase homes rather than rent them, which then adds to their equity. But the boom in home purchases has hurt the apartment properties, and that is why we have been very selective in that aspect. But having said that, we are selective on a number of levels. In 1998, many homebuilding companies almost went under, were unable to pay dividends, and many went bankrupt. But some of these companies became very attractively priced earlier last year. So we examined their balance sheets to find the companies' big picture potential, took advantage of the lowering interest rates and the growing business climate, and purchased those stocks. That made some people nervous, but because of our experience in homebuilding, our perspective is a little broader. And now things have worked out nicely.

Do you maintain the same number of stocks every year? Gadsden: It changes. We have taken a different approach than a number of other REIT funds. We tend to be more diversified, meaning we probably have less concentration in any individual stock. I think we have 60 or so at this point in time, but typically we have about 45 names.

Lieber: This fund is designed for people with less risk tolerance. What we do is add a few more names, spreading the exposure. But we tend to concentrate on specific industries based on performance. We tend to be more prudent, and part of that strategy is not to have too much exposure to any one industry. This is not an aggressive fund from that perspective at all. Usually we try not to go too far to overdiversify.

Some investors will allocate assets by sector. Certainly we are cognizant of the sectors we want to be in and what we do not want to be in. However, we don't say we need to be at a 50% weighting of the index, or at a 10% under or over. We look at the individual stocks to see if we like them. If we see a reason to invest in a given company, then we do so. We gauge the size and the positions based on what the expected returns are, combined with expected risk and volatility of the stock. This is really a bottom-up portfolio construction, even though we take a top-down macro view. We start with a macro view, then lay into the fundamentals, the market, the company, the geographical aspects, the company's balance sheet, and the overall portfolio.

Chelsea Properties Group owns shopping centers in both the U.S. and Japan, and has a large online platform that has helped launch apparel companies like Liz Claiborne on the Internet. What specifically attracted you to them? Gadsden: As of now, Chelsea Properties is the dominant owner of outlet malls, but a few years ago it fell out of favor. We started buying Chelsea in 1999 because we felt it was undervalued on the Street because they were in the outlet sector. Their interest in Japan made some people nervous, but we saw that as a great opportunity. And they have exceeded our expectations and moved into other avenues. The company has since generated some of our highest returns.

Do you believe REITs belong in the everyday investor's portfolio, 529 account, or pension plan? Lieber: By diversifying an overall portfolio, and reducing the level of volatility in that portfolio, you are giving a greater sense of certainty of where your dollars will be at a given point in time. For example, say you have a 529 account for your child. You know exactly when you are going to need the money because you know exactly when your child is going to college. But you don't know if the economy is going to be in a recession, if there is going to be another oil crisis, or if something is going to lower--even for a short time--your overall return. You don't have the luxury with an account like that to wait two or three years for things to bounce back. But when you have REITs incorporated in your portfolio--I'm not saying entirely, I'm saying partially--they tend to give a more consistent overall return. They provide a dividend yield, and that dividend provides a cushion.

Finally, with regard to retirement accounts: the fundamental issue to look at when dealing with age and timing--let's assume excluding REITs or real estate in general from your portfolio--is diversification. By being less diversified, you may be gambling for higher overall growth. And that is okay if you have a long-term horizon or if you are not sure when you are going to need your money so you don't really need to worry about it. Then you can deal with the higher risk. On the other hand, if you are looking at retirement soon, and you don't have a portfolio that dramatically exceeds what you think you are going to need, then you may want more security. And for those investors you may want to include a higher proportion of REITs in their portfolio. It tends to add more stability in their overall pattern of return.

If you need to know X amount of dollars is going to be there, and you are going to be taking Y amount of dollars out every year to live on, but you don't know when you will need to take out a larger amount for an emergency, then something like real estate really does make sense.

What is next for the economy? REITs have done better than other indexes over the last few years; do you think this will continue? Lieber: It looks like the economy is gradually coming back from what I would call a relatively mild recession. We didn't have a dramatic lapse, so the rebound won't be dramatic. My guess is that we should prepare ourselves to get back to fundamentals. We can expect relatively moderate growth over the next three to five years.

Gadsden: Real estate fundamentals, as the economy picks up, should improve. What hurts the fundamentals around the country is supply and demand. Real estate supply in the early 1990s exceeded demand because of overbuilding. The markets got tight as the economy got strong. Now what has happened over the last 18 months is a lightening and a giveback of space. So REITs will parallel the economy, growth-wise.

How do you prove to people that REIT investing is on a par with stocks or bonds? Gadsden: I don't think it is. Real estate securities tend not to move in tandem with S&P 500 large stocks, small-cap stocks, or with bonds. Progressively over the 1980s and '90s they correlated less and less. What that showed me was that real estate securities had a very positive impact in a portfolio made up of traditional stocks and bonds. If you included REITs in a portfolio in 1992, the return nine years later would have increased the total return. So as far as convincing investors of the validity or the attractiveness of investing in REITs, they do have a place in a portfolio as a diversifier and in terms of return.

Lieber: The key element is that REITS have certain characteristics that are much like bonds. They pay out a large dividend so they appeal to investors. As GDP grows, real estate tends to grow as well. Of course, real estate has its own cycle, which is somewhat different than other investments. So their issuance tends to have a different pattern of return, hence their correlation varies. When one investment may be going down, real estate may be doing very well and vice versa. And this is very good for your return.

Gadsden: Say you and I had a building that we rent out to a couple of Fortune 500 companies. The leases are for 15 years and the companies agree to an increase in rent during that period. They are paying you the rent and you are receiving the income from that property. Now those companies themselves might be doing phenomenally or they might be doing less than they were before they came into your building, but as long as they continue to pay the rent, then you continue to do the same business. Their stocks might be reflecting their business fundamentals of going up or going down, but the underlying real estate income is acting independently.

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