Risks and Rewards of Real Estate Stocks

Ken Dawson, a retired aerospace engineer, says he made one of his best real estate investments ever from the living room of his San Fernando Valley home.

“I was sitting on my couch, reading the business section of the newspaper,” Dawson says, “and there were two stories side by side. One was on a big stock market rally, and the other was about the strength of the housing market. So I said to myself, ‘That’s it! I’ll buy real estate stocks and make a fortune!’ ”

Dawson, who says he’s been “dabbling” in the stock market for about two years, didn’t quite make a fortune. But he did make a $1,600 gross profit after he bought 200 shares of stock in a home building company last September for $15 each and sold them last month for $23.

“That’s a 60% profit in only four months,” gloats Dawson. “It beats the heck out of a Christmas Club account.”

Offers Advantages

In today’s volatile stock market, however, Dawson’s shares could have just as easily dropped 60% in value as risen that much. But although buying real estate stocks is perhaps the riskiest real estate investment around, it offers several advantages that physically owning property doesn’t.

One of those benefits is liquidity: It takes only a few moments to buy and sell shares of common stock, in contrast with the weeks or months it takes to buy or sell a home, apartment building, or shares in a real estate limited partnership.

Investors in real estate stocks don’t have the headaches entailed in managing the property, and they have a chance of making a lot more money a lot faster than they would if they purchased an actual piece of property.

Unfortunately, not all real estate stocks rise in value. Only three weeks ago, for example, the value of San Francisco-based California Real Estate Investment Trust’s stock dropped from $11.50 a share to $8 in a single day--a staggering 30% loss in a matter of hours.

Influenced by Market

In addition, even the best real estate stocks tend to be influenced by the overall direction of the stock market and interest rates. If the market soars or interest rates plunge, real estate stocks usually benefit; when the market dives or rates go up, they usually suffer.

If you’re going to buy real estate stocks, you need to determine how much risk you’re willing to take. Wall Street experts say stocks of home building and development companies tend to be your riskiest venture, primarily because they’re extremely sensitive to interest-rate fluctuations.

As a result, those types of stocks usually offer your best chance of making a big profit in a relatively short amount of time--or of losing money just as fast.

Stocks of real estate investment trusts (REITs), on the other hand, usually don’t have dramatic price swings. These stocks tend to attract more conservative investors who like the good annual yields REITs can provide (currently in the 4% to 12% range), but don’t expect any big profits when they sell.

Narrow-Interest Companies

Regardless of what type of real estate stock you buy, most experts suggest looking for a company with relatively narrow interests.

“The company should have a specific focus, and work in a specific geographic region,” says Berle East, a stock market analyst with Alex. Brown & Sons Inc., a Baltimore-based brokerage house.

“Too many companies get into too many other lines of business, and then they get spread out all over the country. Those kinds of companies are nothing but conglomerates--and conglomerates don’t do very well.”

But how do you know what a company does, where it’s active, and how well it has performed in recent years? There are several places where you can find such information.

Start by asking for the company’s annual report. The report will have basic information about the company, what its plans are for the next few years, and how well it has performed in the past.

Obtain Company Reports

You might also want to obtain the quarterly report (called a “10-Q”) and the annual report (“10-K”) each publicly held company must file with the Securities and Exchange Commission in Washington. These forms provide more detailed information about the firm, its financial situation, how it uses the cash it generates, and any legal procedures that could significantly affect the its future performance.

Although 10-Qs and 10-Ks can be difficult to obtain, some real estate companies will send them to you if you say you are a shareholder. If the company won’t provide the documents, Bethesda, Md.-based Disclosures Inc. will sell them to you for less than $1 a page.

One resource used by many analysts is the Value Line Investment Survey, a respected New York-based advisory service that reports on about 130 stocks in seven or eight industries each week. Since the stocks are rotated with each new issue, about 1,700 stocks are covered in a 13-week period.

Although it costs $425 for a full-year subscription to Value Line, you can purchase its latest report on stocks in the real estate industry for $10. Many libraries carry the survey, or a friendly stock broker might give you the latest update for free.

Selecting Stock Broker

Novice stock market investors are often better off following a broker’s recommendations. Ask your friends for referrals if you’re looking for a good broker, and try to get the broker to document how well his selections have fared over the past year or two.

Several analysts are currently leery of home building and development stocks, in part because many of those stocks already ran up in price as the housing market soared over the past two years. However, Kurt Feuerman, an analyst for Drexel Burnham Lambert Inc., in New York, says the stocks of three such companies may continue to rise.

“Two of my favorite home builder stocks are Hovnanian Enterprises and Toll Brothers,” says Feuerman.

Red Bank, N. J.-based Hovnanian, one of last year’s big stock market winners, primarily builds town homes and condominiums for first-time home buyers in the hot Northeast market. Toll, based in Horsham, Pa., focuses on move-up buyers in the same region.

“Both of these companies have a niche, their management is good, and their earnings are accelerating,” Feuerman says. He predicts both stocks, currently selling for $22 a share, could rise to about $30 within a year.

Feuerman also likes the stock of Stamford, Vt.-based land sale company Patten Corp. “The company buys property in recreation areas in the East, subdivides it over a couple of months, and then sells the parcels to city dwellers,” he says.

Patten’s stock “could go from about $18 today to as much as $30 within a year,” Feuerman adds.

Baltimore analyst East likes Rouse Co., a Columbia, Md.-based company that owns 60 regional malls. “Its portfolio is irreplaceable, the malls are doing extremely well, and the company has what could be the best management in the industry,” he says. “The stock is at $33 a share now, but you’ll probably see it go into the high 30s.”

More risky real estate stocks being touted by some Wall Street analysts include Days Inns Corp., an Atlanta-based lodging company. Its earnings are rising fast, and some say the company could eventually become a buyout target.

Another potential takeover target is Honolulu-based Alexander & Baldwin Inc., one of Hawaii’s big landowners and sugar producers. Among A&B;’s better qualities are its strong cash flow and massive land holdings, worth far more than the company’s books show.

Few analysts are predicting big run-ups in the stock prices of real estate investment trusts, but many recommend REITs to conservative investors who want steady income instead of big price gains.

REITs pool their shareholders’ cash and use the money to buy or finance shopping centers, office buildings, apartments or other types of real estate. They don’t pay corporate income taxes as long as they pay out at least 95% of their income through dividends to their stockholders. The dividends are then taxed at the stockholders’ individual tax rate.

Benefit From Reform

Unlike most other forms of real estate investments, REITs are expected to benefit from tax reform because they are primarily designed to provide their investors with steady income instead of big tax breaks. And, since many REITs are currently rolling in cash, they can pick up good properties at attractive prices from syndicators anxious to sell their buildings now that their tax breaks are gone.

Trusts that own portfolios of financially healthy shopping centers and apartment buildings are particularly attractive today, some analysts say.

“Apartment construction should nearly grind to a halt because tax reform took away a lot of the benefits apartment builders used to enjoy,” East says. “As supply gets eaten up, REITs with existing rental properties shouldn’t have much trouble raising rents, and that’ll help their bottom line.

“Shopping centers are always good investments because there are so many barriers for new companies to get into the business,” East adds. Big anchor tenants like Sears or J. C. Penney won’t take space in an area that’s already served by similar stores, he explains, and that tends to help centers that already have large tenants.

Lists REIT Favorites

East’s current favorites include Weingarten Realty, a Houston-based REIT with an attractive portfolio of shopping centers.

“Weingarten Realty is typical of the kind of company we like,” the analyst says. “Despite the horrible conditions of Texas (brought on by the depressed oil industry), Weingarten’s centers have high occupancy rates and good cash flow. And it has the kind of management that can add value to its centers through its management expertise.”

Weingarten’s stock was recently selling for $25 a share, and its annual dividend of $1.56 a share means investors are enjoying a 6.5% annual yield, not including the recent rise in the company’s stock. “We think that dividend could grow 8% to 10% a year, and that means its price would probably go up too,” East adds.

The analyst also likes United Dominion, a Richmond, Va.-based REIT. “The company buys apartments that have been run-down or poorly managed, and then renovates them,” he says. “It operates in a particularly strong housing corridor, the hottest outside the Northeast and Orange County.”

Likes Santa Anita

United Dominion’s recent stock price of $17.50 a share probably won’t change much over the next six months, East says, but its 96-cents-a-share dividend gives it a “fairly attractive” yield of 5.5%. “If you take a long-term perspective and will hold on to this stock for the next five years, you could really make a lot of money,” the analyst says.

Charles Freedman, an analyst for Los Angeles-based Crowell, Weedon & Co., likes the prospects of Santa Anita Realty Enterprises. The Los Angeles-based company derives a handsome income from the Santa Anita Race Track in Arcadia and the adjacent Santa Anita Fashion Center. It also has other shopping center properties, as well as the only race track in Minnesota.

Santa Anita Realty’s stock has been trading at about $32.50 a share, and its $2.04-a-share annual dividend gives it a yield of about 6.25%.

Although many REITs have higher yields--some of them topping 10%--they aren’t necessarily your best investment. “Some of the highest-yielding stocks out there are also the riskiest,” analyst Feuerman says. “If they cut or eliminate their dividend, you’re out of luck.”

Some of the riskier REIT investments--but those offering some of the higher yields and biggest potential price increases--are involved in the medical and hospital fields. Many health organizations have recently formed their own REIT, sold their buildings to the trust, and then leased them back. In many of the deals, the REITs have built-in annual rent increases and will share in profits generated by the facilities.

Among the hospital REITs considered attractive by some analysts are Austin, Tex.-based HealthVest and Costa Mesa-based Health Care Property Investors. Some hospital REITs could be hurt, however, by the financial troubles currently plaguing many health-care providers.

You might also want to consider buying shares in one or both of the two mutual funds that invest only in real estate stocks. Mutual funds allow you to “instantly diversify” your assets because they own shares in dozens of different real estate companies. They have the added benefit of ongoing, professional management.

Each of these funds--Boston-based Fidelity Investments’ Fidelity Real Estate Investment Portfolio and the New York-based National Real Estate Stock Fund--will charge you a “load” equivalent to at least 2% of your investment in order to buy their shares. They’ll also charge you an annual maintenance fee of about $25.

Fidelity’s fund began trading only recently, but is showing a modest gain. “Most of the people in our fund are looking for income and safety, rather than a big killing in the market,” says Barry Greenfield, the Fideltiy vice president who runs the fund.

The National Real Estate Stock Fund is geared toward more venturesome investors who are looking primarily for large price gains rather than steady income. The fund is up a healthy 19% over the past 12 months.

The sponsors of the National Real Estate Stock Fund, National Securities & Research Corp. of New York, also began another fund last week that, like the Fidelity fund, emphasizes steady income over big price increases.