6 REITs for a 'Recovery Portfolio'

Investing in the booming real estate market…?

Lest you think I’ve gone totally off my rocker, let me explain. Last night, I received an interesting phone call from an old friend of mine. Jim’s in his forties, has a wife and a couple of kids, and lives in Orlando, Florida.

Six years ago, when I was vice-president of a telecommunications company, I hired Jim to run a new specialty business we were setting up in his neck of the woods. He knew absolutely nothing about our business, but he was a smart guy and I felt he was the best person for the job. It was the right decision, as Jim was a self-starter and turned out to be a great manager for our new operation.

When I left the business a few years later, I suggested he consider striking out on his own, as he would do a lot better for himself. He still owes me a nice dinner for that piece of advice.

Last year, his sales were over $2 million… this year he’ll likely do four times that. He has 10 full-time employees, and he’s going to be looking for more this year. He’s quickly become the No. 1 contractor in central Florida for the type of business he’s in.

Investing in Real Estate - Buying Unfinished Homes

Then he told me something that floored me: He’s taking some of his hard-earned profits, and has been investing them in Florida real estate. Unfinished single-family homes to be exact.

I couldn’t believe my ears. Naturally I asked him how he could possibly be making money buying real estate in one of the most over-built areas of the country. Here’s what he told me:

It’s a simple business model: You buy unfinished houses in existing developments that have other finished homes. These are houses that are anywhere from 25% to 75% complete… hundreds of them. They’re eyesores to the people who live there and financial burdens to the banks that own them.

Many of the contractors that were building these “spec” houses overextended themselves financially. So they simply packed up their tools and left the bank holding an unfinished house. Obviously, the banks are hot to unload these properties first. Terms are simple: 100% cash.

I just paid $28,000 for a three-bedroom 3,000 sq. ft. house. I’ll probably have to dump another $25K - to $50K into it to finish it off. I then put it on the rental market. I usually sign a rental contract within a week.

Jim said because of the high foreclosure rates in Florida, the rental market is doing very well. Also, a lot of people are migrating from other areas like Detroit, in hopes of finding work in the Orlando area.

He did a lot of figuring before he bought his first one, but he told me with the rates he’s charging, he’ll have his upfront money back in a year or two on most of the properties he buys. Then he’s the owner of a very nice house that he bought for anywhere from 25% to 50% of its actual value in today’s depressed market.

Interestingly, the average investor can do the same thing, but in a much easier fashion than my friend Jim’s doing.

Investing in Real Estate With REITs

There are a number of Real Estate Investment Trusts (REITs) that specialize in residential rental real estate investments.

And this week, these funds are starting to see some handsome moves to the plus side. For instance:

• CMG Realty (CGMRX) is up nearly 10% in the past few trading days.
• Third Avenue Real Estate Value (TAREX) is up almost 5%.
• And Fidelity International Real Estate (FIREX) is 4.5% to the plus side.

What’s going on here? Simple. Three or four years ago, renters were busy buying houses they couldn’t afford. As a result, apartment owners couldn’t give away apartments, and vacancy rates skyrocketed. Then the housing market collapsed.

Add the havoc in the financial markets to the above mix and you have most REITs trading at a significant discount. Now the trend is reversing itself and it might just be the best time in a decade to own apartment and residential real estate REITs.

Others to consider long term are:

• Avalon Bay Communities (NYSE: AVB) a well-run, low-leveraged operation in high barrier-to-entry markets.
• Essex Property Trust (NYSE: ESS) also operating in high-barrier markets.
• And Camden Property Trust (NYSE: CPT) specializing in large apartment complexes.

Watch these plays closely… when they trade sideways for a period of a few weeks or months, consider adding them to your “recovery portfolio.” Next year, you may be very happy you did.

Comments

[j_remington:]

One of the better ideas. Own on the "dips."

Jan 25 11:12 AM

[SharonW:]

At first blush, the idea sounds like it has merits, but in actuality apartment owners are now dealing with the over supply of housing and rents are dropping. Many of those who are forced from the homes don't go on to rent, they go to live with relatives while they rebuild their monetary nest eggs. And other owners have turned to the idea of renting their homes rather than lose them and are finding the same problems...too much supply and competition.

Those REITS you mention are now competing with your friend "the finisher" among others.

Jan 25 04:39 PM

[malach hamo...:]

there's a ton of analysis to be done before making any significant investment in apt reits; they may still suffer rent income erosion when a soft job market steals their pricing power and they are forced to offer significant concessions to attract or retain tenants.

softness in employment, for all the talk of the Wall Street execs being canned, is still concentrated in the lower half of the workforce - those who are more likely to rent. tougher collection and eviction environments, along with the inability to maintain occupancy can wreck havoc with cash flow and income.

Additional softness in these stocks can be anticipated if the credit squeeze continues; even those reits wih reasonably healthy balance sheets are forced to refinance short and intermediate term mortgages which they had gravitated to in 2002 - 2007; as these mortgages must be refinanced, there is often a need to post additional cash if the new lending standards require a lower LTV ratio.

It's not going to be a slam-dunk for quite a while.

Jan 25 07:01 PM

[applesauce:]

I work for a private company that owns over 20,000 apartments. With layoffs
residents cannot pay rents and occupancies are decreasing causing rent concessions of one to two months free rent in Florida. Orlando is overbuilt and the rental market is soft with all the failed condos being rented out, this is called the "shadow market" because it is not tracked. Be careful renting out single houses , being a landlord can be rough and a angry tenent can destroy your property. REITS are selling assets now and are having difficulty getting financing. Three years ago you could borrow 90% of the value, now 65% is more likely. REITS will continue to suffer for some time to come. Cavaet emptor

Jan 26 10:55 AM

[ChipSeal:]

Many REITs have outstanding debt that they may not be able to re-finance. Some are facing loan covenant problems. Be careful!

Jim is working without debt on his finish-to-rent business plan, a far different business model than REITs.

Jan 26 01:39 PM

[Urbane Gori...:]

Good point.... Apartment rates are dropping over here on the 'Left Coast' as well as reported in the SF Chronicle this weekend.... jegan


On Jan 26 10:55 AM applesauce wrote:

> I work for a private company that owns over 20,000 apartments. With
> layoffs
> residents cannot pay rents and occupancies are decreasing causing
> rent concessions of one to two months free rent in Florida. Orlando
> is overbuilt and the rental market is soft with all the failed condos
> being rented out, this is called the "shadow market" because it is
> not tracked. Be careful renting out single houses , being a landlord
> can be rough and a angry tenent can destroy your property. REITS
> are selling assets now and are having difficulty getting financing.
> Three years ago you could borrow 90% of the value, now 65% is more
> likely. REITS will continue to suffer for some time to come. Cavaet
> emptor

Jan 26 05:43 PM