Investing In the REIT Neighborhood

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Management, management, management -- that's what Nancy Holland, who runs the ABN AMRO Real Estate fund, looks for in picking Real Estate Investment Trusts (REITs). Of course, location doesn't hurt, either, whether it's a company that owns apartment buildings or shopping centers. One of her holdings, CenterPoint Properties, is a player in the Chicago commercial real estate market, while SL Green Realty owns properties in midtown Manhattan. Following a growth-at-a-reasonable approach, Holland looks for earnings growth potential and prefers holding stocks for the long haul. The portfolio's turnover ratio is 18%, meaning it turns over once every five years. Over the last year the fund is up 14.02%, not far behind the 15.58% gain for the Morgan Stanley REIT Index and 21.46 percentage points ahead of the Standard & Poor's 500 Index, according to Morningstar. Holland holds a BS in accounting from Saint Louis University.

Barron's Online: What's attractive to you these days among REITs?
Holland: We are looking for companies that have strong earnings growth potential. I think everybody recognizes that fundamentals in the property sector are weak. But we are looking for companies that are going to see a pickup in late 2002 or early 2003. Sectors we would prefer right now are mainly the retail sector or the industrial and mixed-office industrial sectors.

Q: Do you mean shopping centers?
A: Yes.

Q: A lot of REITs have done quite well, haven't they?
A: They've done quite well for about the last 2 &frac12; years. (Editor's note: the Morgan Stanley REIT Index is up 12.46% annually over the last three years, vs. 11.18% for the fund.)

Q: Right. But even in the last year or so, REITs have generally outperformed the market, haven't they?
A: Yes, they have.

Q: Why has real estate been a better investment than stocks during that time?
A: A couple of things have occurred. In 1998 and 1999, real estate did very poorly compared to the broader markets and in fact had negative returns. Real estate then became extremely undervalued, trading at a 20% to 30% discount just to the underlying value of the properties. But we saw that correction in 2000 and 2001.

Q: What's your take on the REIT market in general?
A: For the most part, [REITS] are trading at or slightly above their net asset value. We're comfortable with them trading at a 5% to 8% premium for the long term, so there's still some upside potential. Also, since they pay quarterly dividends, we've got about half a year of those to go.

ABN AMRO Real Estate Fund

(Top 10 Holdings as of June 11, 2002)

Company Ticker
Equity Office Properties EOP
Vornado Realty Trust VNO
Equity Residential Properties EQR
Prologis Trust PLD
Archstone Smith Trust ASN
General Growth Properties GGP
Duke Realty Corp DRE
Simon Property Group SPG
Apartment Investment and Management AIV
AMB Property AMB

Q: What about the property market in general?
A: I think we have to fully acknowledge that property market fundamentals are weak. It differs across the sectors. But we do think that we've bottomed out -- and that as the economy improves, the property market will improve with a lag.

Q: Have you changed what you are looking at as REITs have appreciated?
A: I think that our investment process has stayed absolutely the same; we tend to be long-term investors. We hope for quarter-to-quarter total positive returns. But our philosophy is to look longer term, because that's the correct way to look at real estate.

Q: Surely, though, valuations have increased.
A: Valuations have gotten a lot tighter; [REITs] are trading at plus or minus 5% of net asset value for most of these companies. So, today we probably have more mid- to small-cap real estate companies in our portfolio than we've had in the past.

Q: What do you focus on when you're looking at a stock?
A: To start off, we go through the 36 points that we call quality-and-risk analysis. The most important thing there is our review of management, because if management is not up to par, then, quite frankly, they can't ride out the cycle with our longer-term investment horizon. So, if a company doesn't pass the management criteria, we don't even finish the analysis.

Q: What's next?
A: We will actually then go out and visit the properties, interview management extensively and then prepare our own in-house earnings forecast going forward five years for the company.

Q: Where do you stand in terms of growth vs. value?
A: We are looking for mainly growth at a reasonable price.

Q: What about beaten-down stocks?
A: We'll find some of the beaten-down companies. In the past, Mills Corporation was one of those companies. It had great growth prospects. It had [some] problems with its balance sheet, but that has worked out to be a very good stock for our portfolio.

Q: Recently, office properties was your highest concentration, at about 24%, followed by residential, then retail. Industrials was almost 12%, with diversified at 10.7%.
A: We have actually lowered our exposure to [the] office market and increased industrials. Part of the reason office is so big is because as part of the benchmark, it is so big.

Q: What do you use as a benchmark?
A: The Morgan Stanley REIT Index. But our preference for industrials has to do with how the property cycle will play out over the next 12 to 18 months. And we see that industrials is going to be one of the first sectors to really benefit from the pickup in the economy.

Q: Why have you trimmed your office property holdings?
A: Because they are going to take a lot longer to recover than we initially thought.

Q: Are you seeing more vacancies?
A: I think the economy hasn't picked up as quickly as we had anticipated. As we don't really see a lot of job growth coming forward, I think that office demand is going to continue to lag.

Q: What about on the residential side, apartments in particular?
A: Job growth is weak right now. Secondly, low mortgage rates [are reducing] demand for apartments.

Performance Snapshot

(Total Return as of June 13, 2002)

Year-to-date 1-yr 3-yr*
ABN AMRO Real Estate Fund 9.72% 14.02% 11.18%
Standard & Poor's 500 -11.74% -16.27% -6.75%

Source: Morningstar


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