A Slow, Steady Reconstruction For Real Estate

In 1995, the commercial real estate market continued its steady recovery from the devastation of the late 1980s. For the third year in a row, vacancies for most types of property fell, and rents in some markets edged upward. But despite signs of new life in a few sectors, cautious industry executives say the good news doesn't mark a return to the glory days of soaring asset values and bold construction deals. That means real estate investors in 1996 face a market that offers respectable, but not spectacular, returns.

While the end of the go-go days of the 1980s bodes well for continued strengthening of real estate fundamentals, it meant ho-hum returns for investors in 1995. According to Morningstar Inc., real estate mutual funds were up 10.4% for the year as of Dec. 8. Meanwhile, the Standard & Poor's 500-stock index was up 35.3%.

LAGGARDS. Real estate investment trusts (REITs) have been market laggards. Much of the money that flowed out of REITs in 1994, when interest rates moved up, has not returned. And while most REITs went public promising double-digit earnings growth, many didn't deliver because of heavy debt or competition for deals that limited growth. "There was some overhyping of the business in 1993 and 1994," says Mike Kirby of Green Street Advisors Inc. in Newport Beach, Calif.

Some aggressive building activity has also given investors jitters. Apartment construction is up 70% since 1993. Retailers and shopping-center developers were also aggressive, adding about 260 million square feet in 1995, just 4% off the peak of the mid-'80s.

Although some analysts warn of overbuilding, the construction boomlet creates buying opportunities. Barry Greenfield, who runs the $672 million Fidelity Real Estate Investment Portfolio, likes Bay Apartment Communities Inc. in San Jose, Calif. In addition to building new properties, Bay buys and renovates run-down apartment buildings in Silicon Valley and downtown San Francisco. With rents rising 6% in some spots, Greenfield thinks the stock, now trading around 23, will generate a total return of about 16%.

In the retail sector, the best bets are companies at the higher end of the market, such as Taubman Centers Inc. in Bloomfield Hills, Mich., which are less affected by the building frenzy that has thinned out the ranks of discounters. While a slow retail environment may mean weak growth, Taubman's stock, at 9 7/8, is a bargain at about 11 times cash flow, says Green Street's Kirby.

OFFICE PLAYS. With office vacancy rates dropping in most parts of the country and with new construction rare, vulture investors are hot on office properties. Office buildings were one of the last areas to recover and have the best chance of attracting capital. Chicago real estate magnate Sam Zell may launch an initial public offering for an office REIT in late 1996.

But for individual investors, there is a paucity of office-company stocks to chose from. Fund manager Samuel A. Lieber, who runs the top-performing Evergreen U.S. Real Estate Fund, which is up by more than 26%, warns that many of those stocks are pricey. He sees better plays among homebuilders. Single-family housing starts, after falling 11% this year, to just over 1 million units, will very likely pick up in 1996. Lieber thinks that U.S. Home Corp. is well-positioned because of strength both in houses for first-time buyers and in retiree housing. He figures that the price-earnings ratio on U.S. Home, now around 9.3, could increase by 50% over the next two years.

Many real estate pros expected that the hottest action would come from a wave of mergers and takeovers among real estate companies. But so far, that forecast has not panned out. While there have been some deals among REITs, few REIT executives are willing to take a backseat in any combined company. While much has changed in real estate over the past few years, the egos involved certainly have not.

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