At Home: Residential REITs

05/12/2006 12:00 am EST

Focus:

Roger Conrad

Founder and Chief Editor, Capitalist Times

Income expert Roger Conrad astutely shifted his REIT focus last year from commercial residential and offers his two favorite players. Meanwhile, Richard DeAgazio, with Boston Capital, presents a new, non-publicly traded vehicle in the residential sector.

"About a year ago, we highlighted a major shift in the real estate market: The rise of the residential rental sector," says Roger Conrad in Personal Finance. "And we put our money where our mouth was, by swapping the Income Portfolio’s commercial real estate investment trusts (REITs) for a handful of residential-focused REITs. Since our swap, our five residential REITs have done even better, scoring an average return of more than 30%.

"Residential REITs have revived for one major reason: rents are recovering after several years in the doldrums. Earlier this decade, rock-bottom mortgage rates made almost everyone a potential homebuyer, while apartment REITs’ margins sagged and cash flows and dividends lagged. The rent recovery is being fueled from two sources. First, the cost of renting has hit a historic low versus the cost of buying a home. As a result, more and more bargain hunters have been choosing to rent rather than buy. Second, mortgage rates have been rising in earnest, pushing up the cost of buying a home further still.

"We’re still a long way from achieving parity between the cost of renting a home and the expense of buying one. That means a lot more room for improvement for residential REITs, which are already seeing their rents rise and vacancy rates decline. Best of all, despite their impressive gains during the past year or so, residential REITs haven’t come anywhere close to scaling the heights commercial REITs have.

"Apartment REITs’ relative value has made them increasingly attractive as takeover targets, both from private capital and larger players in the business. That’s a clear sign smart money views apartment REITs as still trading below private market value, one of the things that attracted us to the group last year. Our two favorite US residential REITs remain the pair in the Income Portfolio: Mid-America Properties (MAA NYSE) and Home Properties (HME NYSE).

"Mid-America posted a solid 6.7% jump in 2005 funds from operations (FFO) and expects its first quarter 2006 to come in well ahead of expectations. Its shares have soared since our recommendation last year. But its operating success and relatively low price of 2.66 times book value make it increasingly attractive as a takeover target. So does its relatively low market-cap. We’re raising our buy limit to 55.

"Home Properties has also been posted strong results, despite damages to the Florida properties from Hurricane Wilma. With the bulk of the REITs rental residences located in the Northeast it has often been on the losing end of competition for holding renters in recent years. Happily, it seems to have turned the corner. Home has a little further to go on the recovery trail than Mid-America. But the direction is clear and the shares are cheap yielding over 5%. HME is a buy up to 52."

For more sophisticated real estate investors seeking an SEC-regulated, but non-publicly traded opportunity in the REIT market, we note that long-time Money Show exhibitor Boston Capital Securities gained clearance from regulators to fundraising for a $1 billion real estate investment trust. Founded in 1974, Boston Capital is one of the country’s largest owners of affordable and multi-family housing units, having raised over $4 billion.

Craig Douglas of the Boston Business Journal explains, "A new REIT, formally called the Boston Capital Real Estate Investment Trust Inc., will focus on residential apartment complexes in ‘secondary’ markets where there is relatively robust employment and moderate home-price appreciation. Among the areas targeted: Jacksonville, Fla., Portland, Ore., Salt Lake City, UT, and Plano, Texas.

"Richard DeAgazio, president of Boston Capital, which is managing the fundraising aspects of the new REIT, said the fund’s objective is to provide average investors access to a diverse real estate portfolio offering cash dividends and long-term capital appreciation. ’I think we have an interesting story to tell,’ said DeAgazio, noting that rising interest rates and a cooled housing market bode well for multi-family rental properties. ‘We believe the apartments sector is an ideal hedge against inflation.’

"Since 1998, REITs have raised more than $214 billion from public stock offering, private share placements, and debt financings. According to the National Association of Real Estate Investment Trusts, its NAREIT index, which tracks share prices for all tax-qualified REITs on the NYSE, ASE, and NASDAQ stock exchanges, have clobbered most major stock indices over one-, three-, five-, and ten-year intervals. Last year alone, the index generated a 12.2% return vs. 4.9% for the S&P 500.

"Boston Capital’s REIT will offer shares at a fixed price of $10, with a minimum upfront investment of $1,000. Though the fund is publicly registered it will not be traded on a stock exchange. DeAgazio said the initial goal is to raise the $1 billion needed to launch its investment strategy and establish a steady–and growing–dividend payment plan. Those efforts are expected to last for several years.

"In 2015, the REITs shareholders will have the opportunity to vote on whether to list the fund’s shares on a public exchange, continue as is, or dissolve the operation entirely. For those needing liquidity beforehand, Boston Capital will buy back an investor’s stake for $9.15. ‘We expect after some years to either list or liquidate," DeAgazio said, adding that Boston Capital is a shareholder in the new REIT."

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