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No. of Recommendations: 30
I believe that today's REIT prices, on balance, remain within the range of fair value. Perhaps slightly on the high side of fair value, but not enough to cause me to worry a lot. But that doesn't mean that we're entirely free from pockets of irrational exuberance in Reitdom. The topic of HPT is perhaps just one example. I have a “dirty dozen” observations that I'd like to share with you. None of you will agree entirely with this list, of course, but perhaps it might be a topic for future discussion.

And please DO remember that what follows are the opinions of just one guy who, despite his years of hanging around REIT world, will likely be wrong about the near-term direction of many (or even most) of the following stocks (but, if I'm right, won't perform well relative to their peers if we use a 1-2 year time horizon):

1. Hotel Exuberance. Fully 7 of the top 10 performing REIT stocks this year within my 87-REIT model are hotels, including LHO, HMT, MHX, FCH, HOT, HPT and KPA. The gains in these stocks, in Q1 alone, range from 38.0% for LHO to 15.8% for KPA (price only). I will cheerfully acknowledge that the prices of these stocks were probably too cheap at the end of last year. But they are now trading at or about pre-September 11 prices, despite (a) what will likely be continuing weak RevPar performance this year, (b) the risk of another major terrorist attack in the US, which could decimate the industry's plans for a recovery in '03, and (c) although hotel REITs have normally traded at lower AFFO multiples than those of other sectors (for obvious reasons), today's prices are reflecting above-market AFFO multiples – but on the basis of '03 (not '02) AFFOs! The bull case for the hotels is substantially reduced supply, leading to 4-6% RevPar growth in '03 and '04. I would submit that that kind of growth is already baked into the prices of these shares, at least for '03. Do we now look to '04 growth to drive prices further?

2. Yields! The other three REITs among the top 10 performers: Tanger, +28.4% YTD; Crown American, +24.9% YTD; and “CARS.” +15.6% YTD. Yields as of December 31, 2001? 11.7%, 10.8% and 7.8%, respectively (oops, how did Capital Automotive sneak in there?).

3. The Last Shall Be First. Associated Estates, an apartment REIT that hasn't exactly distinguished itself for superior management, FFO growth or stock price performance over the years, now trades at the highest AFFO multiple (and is the best stock performer this year) among its peers. This is despite its 78% leverage ratio and 130%+ payout ratio. Could its beginning-of-the-year 10.9% dividend yield have had anything to do with this?

4. We Love Washington. This illustrious blue-chip REIT (WRE) is now trading at 17.2x forward-looking AFFO and at a 35% NAV premium. Growth forecasts? 2.5% this year and 7% for '03. This is one mighty fine company with a great track record, but is it worth a 35% NAV premium? Hello?

5. No respect. Both Post Properties and Mid-American, apartment REITs that have not exactly knocked our socks off with extraordinary management or tremendous AFFO growth, are trading at higher NAV premiums than Avalon Bay. Dick Micheaux must be waking up with nightmares, wondering why everyone hates this REIT. Sure, AVB's got lots of Northern California assets, but this high barrier market will definitely be back, and AVB will continue to create value via its strong development pipeline.

6. Does Anyone Care About NAVs? Tanger, mentioned earlier as one of Reitdom's best performers this year, trades at an NAV premium of 26%, higher than Chelsea's. Tanger's AFFO growth is expected to range from 1% to 2% for the next two years, while its debt leverage is over 60% and its payout ratio is a rather uncomfortable 90%+.

7. More of Rodney Dangerfield. Health Care Properties is a very solid REIT, owning healthcare assets. But it must depend upon external growth to fuel respectable AFFO and dividend growth over time, while its payout ratio is about 97%. It sells at a forward AFFO multiple of 12.3x, which is higher than that of Equity Office (12.0x). Yes, EOP does face a year or two of sub-par growth but, geez, come on, guys!

8. “Uneasy is the Head That Wears…” Anyone claiming that Crown American owns high-quality mall assets should be given two aspirins and put to bed. Despite its giant-sized leverage of 77%, its AFFO growth rate will be a puny 4% or 4.5% for as far as the eye can see. And its payout ratio is nearly 95%. Yet its stock trades at a higher AFFO multiple than General Growth, perhaps the best-managed REIT in the mall sector and whose growth rate will be near double-digit range for each of the next two years despite lower debt leverage than CWN.

9. No Love for MH REITs. I really like the manufactured home REITs for their stable and very respectable AFFO growth rates, their immunity to overbuilding and their recession-resistency, among other fine attributes. But their shares are languishing this year; CPJ, MHC and SUI all trade at NAV premiums of less than 5%, well below the average for the REIT industry.

10. Huh? The shares of Getty Realty, a triple-net lease that just recently did an IPO and which has already stumbled out of the gate due to its inability to accurately forecast environmental clean-up costs, are trading at a 17.5% NAV premium. Say what?

11. Irrational Exuberance Misplaced? New Plan Excel is a neighborhood shopping center REIT that has had more than its share of problems over the year and is now being led by a new management team. It has shown little ability to create substantial value for its shareholders, pays out over 100% of AFFO in dividends and is expected (by Green St) to grow its AFFO by just 3% this year and a tad below 5% next year. Yet its shares are enjoying huzzahs from investors, trading at an NAV premium of almost 20%, well above all its peers except Kimco and tied with that of Weingarten.

12. Poor Sam Zell. Equity Office, led by one of the best and deepest management teams in Reitdom, has seen its shares wallow in negative territory virtually all year despite a gain of 8.3% for the RMS index this year. It presently trades at the same NAV premium as that of Highwoods, which isn't a bad office REIT but one that can hardly be put in the same league as EOP.

What does all this mean? It's hard to say. This has been another tough quarter for those REIT investors who like to invest in the blue-chips with the objective of enjoying a safer investment profile and, hopefully, reaping better total returns over time. I would also suggest that today's REIT investors aren't terribly concerned with NAV estimates, if, indeed, they even look at them. In my opinion, due to their relative underperformance, the highest quality REIT organizations, generally speaking, offer the best prospects for capital appreciation over the next 12-18 months. Whether I am right or wrong will, of course, only be determined with hindsight. Investing is a very humbling endeavor.

Ralph
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I see that USV did not make your list. Any thoughts on USV?
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Just remember that markets are efficient.

If you believe that then go ahead and buy NXL at $20 or Getty at a 17% premium. If not perhaps its time to look at EOP or AVB.

Ralph, is the apartment REIT you mentioned Mid-American or Mid-America (MAA)?
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<<I see that USV did not make your list. Any thoughts on USV?>>

It is not one of the 87 REITs in my valuation model (due to its smallish size, and NNN-nature of its properties), but the stock doesn't seem to have caught fire like some of the other "lesser respected" REITs. This could be due to the financial strength of some of its tenants (or the lack thereof), but I do not follow the stock and thus really can't comment on its merit as an investment.

Ralph
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<<Ralph, is the apartment REIT you mentioned Mid-American or Mid-America (MAA)?>>

It is MAA. Again, I do not follow this company closely, but unlike USV it IS in my REIT survey. My recollection is that most of the assets are located in Florida, Georgia, Tennessee and Texas, which are of course low barrier to entry markets. I recall some data showing that same-store NOI growth has been below that of most of its peers. (I am not sure of this, and so please feel free to correct me on it). Dividend coverage is very tight; "free cash flow," as defined by the company, was $2.37 last year (up slightly from $2.34 in '00), and the dividend is $2.34. AFFO estimates for this year and next are below the current dividend rate (though I am not suggesting that a cut is imminent (I just don't know). In Q4, same-store NOI was up 1.2% (but was slightly negative for Q4).

Ralph
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Although I can't dispute your comment on WRE, it is good for my morale to have something hitting new all-time highs while I wait for our S&P500 mutual funds in IRAs to recover.

You didn't mention UDR which is selling at a P/E of 40 (and also hitting new all-time highs), according to the newspapers. Is P/E totally irrelevant here? I've long been concerned as we own quite a bit of this, but they seem to hang in there. I realize they are realigning (upgrading) their properties.

brucedoe
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<<You didn't mention UDR which is selling at a P/E of 40...>>

UDR's new management is certainly taking steps in the right direction, and its class B assets are very much in vogue today. That's the main reason, I think, why the stock has done well relative to its peers. However, the company still has a way to go, and its debt leverage is still pretty high relative to its peer group. My belief is that UDR's stock is a bit overpriced, but not hugely so. Try to keep that 40x p/e ratio in perspective, as it's based on net income. On an AFFO basis, the multiple is 12.3x, pretty much in line with its peers.

On a completely unrelated topic, I have finally learned why (for those who care) the new edition of the book hasn't been available on Amazon.com. It seems that the Amazon folks accidentally switched codes; according to Bloomberg, "They have the first edition coded as the new edition, and vice versa." Amazon has now been notified, and will most likely get it fixed within the next few days.

Ralph
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Reitnut & Others:

Great posts and just what I needed.

As almost 100% of my portfolio was in REITS by Jan 2000, I have been trying to reduce this percentage, but have fallen in love with these winners and have a hard time figuring what to sell.

Any other opinions as to Reits that are much overvalued?

Thanks
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