Quick Take: This year may go down on record as one of the worst for U.S. and global equity markets, with the vast majority of stocks and sectors deep in the red so far. The real estate sector, however, has been a bright spot. While REITs themselves don’t typically deliver huge returns, they can provide a cushion in a declining market environment with their high dividend yields as well as capital appreciation.
T Rowe Price Real Estate Fund (TRREX), a strong performer in the sector, gained 10.9% for the 12-month period ended July 31, 2002, while sector funds on average fell 20%. For the three-year period ended July 31, the portfolio edged out its peers, rising 13.7% annualized, versus a gain of 12.4% for the average real estate fund. The Wilshire Real Estate Securities Index, which is the fund’s benchmark, gained 8.9% for the one-year period, and 13% for the three-year period ended in July.
David Lee, who has managed T. Rowe Price Real Estate fund since its inception in October 1997, generally favors large-cap companies in mainstream real estate sectors like apartments, retail and office properties. As of June 30, the portfolio had about $113 million in assets comprising 38 stocks.
The Full Interview:
S&P: What kind of stocks do you look for?
LEE: We typically like to invest in real estate companies that have strong balance sheets, strong portfolios, and that are operating in vibrant markets. We have a bias toward management teams that are `value creators’ — that is, they add value by consistently growing net asset values on a per share basis. Most of our holdings are highly-liquid, large-cap names in mainstream segments of the industry.
Although we like the substantial dividend yields provided by REITs, our investment approach is more balanced. We like to focus on total return, combining distributions with capital appreciation. We have the flexibility to own stocks that are not `purely’ real estate stocks, like homebuilders, health care REITs and mortgage REITs, but we tend not to invest there. On a risk-adjusted basis we don’t find them attractive investments.
S&P: Why do you keep the fund so concentrated?
LEE: There are hundreds of REIT stocks in the U.S. to choose from, but we like to make meaningful bets on our favorite holdings. Despite the concentrated nature of the portfolio, I think we are sufficiently diversified. Our holdings themselves comprise a highly varied portfolios of assets.
S&P: In the first half of 2002, real estate stocks performed very well, while most of the overall market plunged. Why did the REIT sector do so well?
I think investors were attracted to the dividends and high yields that REIT stocks provide, as well as their cash-flow characteristics and the contractual nature of these businesses. However, fundamentals in the real estate industry are actually weakening — REITs are not immune to the downturn in the overall economy, but they can provide a bit of a buffer from a weak economy.
Our fund gained about 12.8% in the first half, while the S&P 500 dropped 13.2% and the NASDAQ Composite plunged nearly 25%.
Our fund’s performance in the first half of the year was buoyed by superb returns from our retail holdings, particularly mall operators like Simon Property Group (SPG) and General Growth Properties (GGP), which have benefited from relatively robust consumer spending.
S&P: What are the fund’s largest holdings?
LEE: As of June 30: Equity Office Properties (EOP), 7.1%; Vornado Realty Trust (VNO), 4.9%; Simon Property Group (SPG), 4.0%; Equity Residential (EQR), 4.0%; Boston Properties (BXP), 3.9%; ProLogis Trust (PLD), 3.6%; Avalonbay Communities (AVB), 3.4%; Regency Centers (REG) 3.3%; Camden Property Trust (CPT), 3.1%; and Weingarten Realty Investors (WRI), 3.0%. These ten stocks represented 40.3% of the portfolio’s total assets.
S&P: What are the fund’s largest sectors?
LEE: As of June 30: Apartment/residential, 21.3%; Office, 20.3%; Shopping Centers, 10.1%; Regional Mall, 8.8%; Industrial, 8.7%; Diversified, 7.2%; Office & Industrial, 6.4%; Manufactured Housing, 4.4%; Lodging & Leisure, 4.4%; and Self Storage, 2.4%.
S&P: The REIT sector seems to have sold off a bit since the end of June. Has this made it more attractive to you as a buyer?
LEE: The sector has sold off because the economic doldrums in the country have deepened. This is clearly a troubling sign. However, as the stocks have corrected some, their valuations relative to their net asset values have indeed made them more attractive buys.