Real Estate Funds Help Ground Your Portfolio

Mike Oliver has his eye out for the “Texas state bird,” and so far he’s happy to report that he hasn’t spotted many.

Oliver isn’t talking about mockingbirds--the Lone Star State’s official winged creature--but rather construction cranes, which dominated the skylines of Houston and other cities during the boom years of the early 1980s.

Too many construction cranes are a bad sign for Oliver, who runs a real estate mutual fund, because they indicate that more supply is coming to market, with the potential to depress prices. The fact that construction cranes aren’t easy to spot these days explains why he’s optimistic about real estate.

Several mutual fund groups apparently share this sentiment and have added real estate portfolios to their lineups. Four such funds have arrived over the past year and a half, boosting the current count to 10.

“Real estate has been in a severe recession in most parts of the country, and prices for some properties have dropped below what it would cost to construct them,” says Bob Benson, portfolio manager of the Boston-based Pioneer Winthrop Real Estate Investment Fund, which debuted in October. “With the economic rebound, we see an opportunity for appreciation and increasing cash flow.”

The specter of falling home prices is still fresh in the minds of Californians, but there is something to be said for owning a real estate fund as a small part of a well-mixed investment portfolio. For starters, real estate is a major asset category to which millions of people, despite what they might think, don’t have adequate diversification. It’s one thing to own a home or a rental property or two, quite another to have a stake in different geographic markets and property types.

Real estate funds typically have holdings in many states, and some take a global slant. Major property types include apartment complexes, retail centers and industrial parks. Office buildings are also within the investment range, although most funds are avoiding this depressed sector right now.

In fact, the mutual fund route is a pretty efficient way to own real estate. Fund shares can be bought or sold in a day, management and other expenses typically run less than 1.5% a year, and funds are open to truly small investors--those with as little as $100 to $2,500.

There are other benefits too, including professional management, diversification, automatic dividend reinvesting and the ability to hold real estate within a tax-sheltered individual retirement account.

Mutual funds don’t own individual properties per se, but rather real estate-related common stocks, especially real estate investment trusts, or REITs. One hallmark of REITs is that they can avoid corporate taxes as long as they pass on 95% of their net income as dividends to shareholders. This explains why real estate funds offer reasonably attractive yields--currently about 3.5% on average.

REITs come in various forms. Right now, trusts that manage apartments in the Southwest (excluding California) are hot owing to solid economic growth and low vacancies that reflect a drop in construction a few years ago.

Benson believes Southern California’s real estate market has seen the worst but probably won’t start to recover for another six to 12 months. Oliver, who runs the Chicago-based PRA Real Estate Securities Fund, is more negative, citing low job formation and high taxation as important drawbacks.

Whether or not you agree with these opinions, a real estate fund can allow you to diversify outside of the Southland.

While REITs and real estate funds are often purchased by income-seeking investors, they shouldn’t be considered low-risk. The funds fell 16.9% in 1990, for example. It’s not misleading to think of them as higher-yielding portfolios of small stocks.

Since 1990, however, declining interest rates have pushed up the value of yield-oriented investments, and a drop in new construction has enabled real estate prices to begin to recover. Real estate mutual funds finished up 22.6% on average in 1993, their third double-digit gain in a row.

One question now is whether the recent surge in the number of REITs coming to market--not to mention REIT prices--could point to the emergence of a frothy, speculative era.

Oliver thinks not. The reason more REITs debuted in 1993 was that traditional financing for the industry has dropped off--mirroring the retreat of banks, thrifts, limited partnerships and other sources of capital, he explains. That has forced existing companies to raise cash by selling stock.

“What’s happening is that the industry is deprivatizing,” he says. “If there were a lot of new real estate companies forming, we’d be scared to death.”

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Investors say they are making progress understanding financial matters, yet many are still having trouble with basic concepts, according to a survey of employees in 401(k) and similar retirement plans by John Hancock Financial Services of Boston.

Sixty percent of the 813 people polled considered themselves more knowledgeable investors than a year or two ago, and 44% said their employers had increased the quantity of investment materials relating to their retirement plans.

But 40% didn’t know that balanced funds hold stocks, bonds and cash, and 44% didn’t know that short-term debt securities are found in money market funds.

And just 26% correctly answered that the best time to transfer into a bond fund is when interest rates are expected to fall.

Respondents were between the ages of 25 and 65 and were contributing money to their retirement plan at work.

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Morningstar Mutual Funds, the independent fund rating service based in Chicago, has named Fidelity Magellan fund chief Jeff Vinik “manager of the year” for 1993.

Morningstar’s list of the year’s top managers honors those who “best demonstrated the investment skill, the commitment to shareholders, and the courage to differ from the consensus that is necessary for superior long-term performance.”

Magellan, the nation’s biggest stock fund, gained 24% last year under Vinik. Morningstar also named Edward Owens, manager of the Vanguard Specialized Health Care fund, first runner-up, followed by Don Chiboucas of Thomson Opportunity fund and Hakan Castegren of the Harbor International and Ivy International funds.

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The 12.07% average gain logged by California municipal bond funds in 1993 marked their best showing since a 17.23% return in 1986, Morningstar says.

Returns on the California tax-free portfolios were in line with those achieved by other single-state funds.

Real Estate Funds

Here are key facts on the largest real estate mutual funds.

3-year Max. total sales Phone Fund return load (800) Cohen & Steers Realty N/A None 437-9912 Evergreen Global Real Estate +88% None 235-0064 Fidelity R.E. Investment +87% None 544-8888 PRA Real Estate Securities +75% None 435-1405 Templeton Real Estate +86% 5.75% 237-0738 United Services Real Estate +63% None 873-8637

Excluded from the list are three newer funds: Evergreen U.S. Real Estate (No load; (800) 235-0064), Franklin Real Estate Securities (4.5% load; (800) 342-5236) and Pioneer Winthrop Real Estate Investment (5.75% load; (800) 225-6292).

Source for total-return numbers: Lipper Analytical Services, Summit, N.J.