The Upside Of The Downturn In Real Estate

The "for sale" signs are out from coast to coast, and liquidations of distressed properties have become routine. But bargain hunters are only beginning to turn up at the nation's largest continuing auction of depressed real estate--the stock market. Shares of companies that own properties, from nursing homes to yuppie shopping centers, are selling at fire-sale prices.

With the exception of real estate investment trusts (REITs) specializing in health care, real estate companies were among the most heavily pummeled equities in recent months. Many stocks declined 50% or more during 1990, and even the strongest real estate companies are trading at well below their 1990 highs (table).

'BULL CASE.' The decline has been so precipitous that it may have created a buying opportunity. Many real estate stocks are at prices well below the estimated value of their underlying assets. Some REITs--companies holding real estate assets--have fallen so far that their yields have climbed to 10% or more. "These stocks have reached valuations that haven't been seen since 1974"--when a real estate downturn pummeled REITs--"and REITs have far stronger balance sheets than they did in those days," notes Robert Steers, a principal of Cohen & Steers Capital Management, which specializes in real estate stocks.

True, the real estate market may not have reached bottom quite yet. But even the most cautious investment pros are testing the waters by buying into REITs and other land-development companies. "The bull case is that interest and mortgage rates are down, so the REITs may be able to refinance their debt," says Barry Greenfield, manager of the Fidelity Real Estate fund.

Greenfield is unconvinced that the real estate woes are over. But improved valuations have persuaded him to reduce his fund's cash position to 10%, half its year-ago level, and he is cautiously buying the shares of high-quality real estate stocks. His favorites include New Plan Realty Trust, a New York-based REIT, and Houston's Weingarten Realty Investors, which owns and develops commercial real estate throughout the Sunbelt.

New Plan, Weingarten, and a California REIT, Western Investment Real Estate Trust, are popular with institutions because of their minimal debt and record of adroit property selection. New Plan, which owns shopping centers throughout the Northeast, stands out for its $140 million cash hoard, which makes it well-positioned to buy distressed properties for a song. "New Plan is clearly the cream of the crop from a balance-sheet standpoint," says Steers. True, New Plan is paying out in dividends 98% of its cash flow--but the company has been a standout at raising low-cost capital that can be used to expand its holdings. New Plan recently raised $75 million in a stock sale to a Dutch pension fund.

As a group, the safest bets are REITs that invest in health facilities--hospitals, mental health centers, and nursing homes. These are noted for favorable demographics and a chronic shortage of facilities. And unlike the companies that actually operate hospitals and nursing homes, health care REITs are only indirectly affected by the cutbacks in federal reimbursement. "The REITs are only interested in the lease payments," notes analyst Robert A. Frank at Alex. Brown & Sons Inc.

At the opposite end of the real estate spectrum--still uncharted territory for most investors--are the companies that own mainly undeveloped land. One conspicuous example is Catellus Development Corp., which was spun off from Santa Fe Pacific Corp. A year before Catellus went public last November, the California Employees' Retirement System paid $38 a share for a 20% stake in the company. The recent price: a little less than $10.

Horror stories such as Catellus abound. But just as real estate investors gravely misjudged the market of the late 1980s, they may also be proven wrong in their gloomy assessment of the 1990s.