WHETHER OR NOT A SUSPECT IS BEING LED INTO OUR FEDERAL COURTHOUSE. MORE INFO TO COME. THERE HAVE BEEN CONFLICTING REPORTS, SO THIS WILL BE EXCLUSIVE--AMONG US BOSTONIANS,

THE RUMOR IS THAT ARREST HAS BEEN MADE DESPITE CONFLICTING MEDIA.

We had a serious competition last spring; I had Eqinix (EQIX) and Ventas (VNTR) which were great picks, but I was narrowed out by short sales on Ambassadors Group (EPAX) and Bank of Ireland (IRE). These guys are tough to compete with, especially some of the savvy tech guys, and financial short sellers. However, this year, we are starting the contest a little late, and I have two picks I would like to share.

8X8 (EGHT) and Cyrus One (CONE) are two of my picks as I approach the final days our selection period, I have a good feeling this year. We all have skin in the game, so this should be a feisty rematch. Feel free to provide input!

While I would like to pretend I am good enough to have plucked these two out of thin air, I have been watching 8X8 (EGHT) and Cyrus One (CONE) very closely this past winter. I waited for both companies to report, and, liked what I saw. I am confident both companies should experience significant appreciation this spring.

I studied the trade all weekend and jumped in this morning. Lowest debt/market cap of all mall REITs, highest price/psf of all mall REITs. FFO came in the midpoint of guidance, with same store NOI way ahead of estimates, and ahead of peers. Trading at a -7% discount to NAV when its has averaged a $83.17 for the past month compared to the one year average spread of +3.668 compared to todays NAV. I am rarely excited about a trade. This is the first time it has crossed 20 RSI without the index falling in tandem all year.

In the long term, I am concerned about their Asian development plan, but overall feel good.

Very excited about this trade, I will update you guys on how it goes.

Steve

Disclosure: I am long [[TCO]].

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

However, with the MSCI I-Shares REIT Index (RMZ) and the Dow Jone's Residential REIT Index (DJURN^) down 6.21 percent and 6.83 percent since September, it appears we have missed the overbuilding cycle altogether, and skipped right to the bust.

What Is Different in 2012?

On the surface, 2012 appears to present us with an extremely favorable environment for multi-family development. Quantitative easing has driven interest rates down to the rock bottom levels, and we have seen vacancies in multi-family rapidly decline since 2009. However, U.S. total commercial construction spending is at a current level of 45.40B, down from 47.54B in October, representing a decrease of-4.50%.

The Difference: Lenders

What is different in 2012 is the highly constricted lending environment which has disrupted the traditional regressive bubble model. While lenders are willing to originate loans to single family home owners, Institutional lenders have changed the way they do business.

NMHC's quarterly survey of CEO's and senior executives of apartment related firms nationwide, covered by NAREIT's article Multi-Family Market Fundamental's Slows (11/2/2012) reported:

"The bulk of the survey participants, 73 percent, reported that financing for new construction is only available for top-tier markets or properties."

www.reit.com/Articles/Multifamily-Market-Fundamentals-Improvement-Slows.aspx

This is in stark contrast to nearly every other economic cycle of real estate in the past, where periods of success in real estate have been followed by periods of overbuilding.

Still Strong

Fundamentals remain strong in the multi-family sector. Much of the growth we have seen between 2009 and 2012 has been the product of internal growth, driven by rent tenant upgrades and a horrible housing market.

While I believe fundamentals will remain strong, multi-family REITs momentum will be stunted by a lack external growth and a slower pace of internal growth through housing recovery. Driven by the fear of new housing coming online through 2013, I believe we have already seen our first round of momentum investor's dropout off the apple cart.

2013: High Yielding REITs and Low Interest Rates Equals…

An article recently published on SA titled: The Illusion of Causality Between Treasuries and REITs." by Sholam Yaffa ( pointed to a lack of empirical evidence supporting a correlation coefficient between treasury yields and REITs yields. Sholam was right, however, treasury yields have never really been accepted as a divergent corollary indicator in the first place.

seekingalpha.com/article/933111-the-illusion-of-causality-between-treasuries-and-reits

Interest Rate Sensitivities of REIT Returns ( Webb, Myer, Ling 2003), published by the International Real Estate Review, analyzed seven different interest rate proxies for equity REITS and established that:

"The OLS results for the entire 27-year sample period suggest that only changes in bond yields (HIGH in particular) have a significant impact on the returns of equity REITs."

www.umac.mo/fba/irer/papers/past/Vol6_pdf/001-021%20US1.pdf

High yielding corporate bonds should be viewed as a competitor, rather than an indicator, when evaluating their effect on REITs. My prognosis for 2013 is that rates will remain low due to QE3 and dividend yields will become more attractive.

The following chart illustrates the comparison between Baa Corporate Bond Yields and NAREIT MSCI REIT Index (RMZ^).

How I am Valuing Multi-Family REITs in 2013: Modified NAV

As I have expressed, I believe that higher yielding REITs, with solid fundamentals will serve as bond proxies in 2013. If I am right, the higher yielding REITs, with strong balance sheets, and reasonable growth prospects will be the most appetizing to investors seeking yield and ROI.

My valuation strategy moving forward is a modification of NAV. My modified NAV is based on a trailing twelve month (TTM) NOI. This differs from forward looking NAV valuations that account for growth via estimates of future straight line rent increases. While I will take growth prospects into account in my decision making, I believe my modified NAV will give me a better indication of a REITs current asset level value.

Why I am Buying United Dominion Realty (UDR) at $21.00

For my own portfolio, I am going to buy United Dominion Realty at $21.00. With a current price of 23.44, and an industry wide bearish moving average, I think we will reach this level soon. A $21.00 valuation would give United Dominion a dividend yield of 4.2%, with negative spread of 26 basis points compared to Baa corporate bonds daily return index. A $21 price target will represent a 23% discount over my NAV estimate of $27.39.

What I Like: United Dominion Realty has $82 million cash on hand, and has a history of disposing outdated properties and investing significant capital into tenant upgrades to spur internal growth. Their current strategy of divesting from markets such as Florida, Arizona and Texas, generated proceeds of over $400(M), and was a swift exit from markets vulnerable to unfavorable price to rent ratios. Currently, the company maintains a healthy diversification in fundamentally strong markets, such as California, Washington D.C., and Boston, where rent to own spreads will remain high. The Average occupancy of United Dominions portfolio is very strong at 95.6%, and same store occupancy through 2013 should stabilize at these levels.

Risks: They have a development pipeline that could negatively impact, internal growth and stabilized rent (due to decrease tenant upgrades and leasing) on same store properties should they need to divert capital. However, through equity offerings, redemption and paying down credit lines, the company has a liquidity of over 1 billion through a combination of cash and un-drawn credit facilities. This should provide ample wiggle room in terms of United Dominion's immediate capital needs for debt maturities, development and capital expenditures.

NAV: 27.39

Current Share Price: $23.85

Assumed Cap Rate: .065 or 6.5%

Debt Coverage Ratio: 2.7X

FFO Multiple: 18.8X (19.6X is the industry Average)

Dividend Yield: ( 3.75%) (3.22% is the industry average as of 11/9/12)

FFO/Share Growth

Debt Maturity

Dividend Yield Spread to Baa Corporate Bond Yield (One Year Percentage Change)

To surmise my estimates, 2013 will lack the growth the past three years the market has afforded to multi-family REITs, however, I do not believe the selloff is a product of the traditional boom bust cycle of real estate. Fundamentals will remain strong for multi-family REITs with solid management and great locations. As bond yields plummet, multi-family REITs will attract a new kind of investor. Bond investors and dividend hunters seeking yield and balance sheet strength, should be patient, and buy at discounts to NAV in order to capitalize on moderate growth and high yield in 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Investment Thesis: Watch Apple's exposure to storefront real estate, when trouble becomes evident (storefront closing/downsizing) it is time to short.

With the projected growth of e-commerce and the number of internet users in the next two years, along with Apple's managerial concerns over storefront overhead, I believe that Apple's commitment to retail store fronts pose a significant threat to it's balance sheet in the next two years. Look for further signs of distress to assess a short sale opportunity.

Risk form Online Retail:

Interactive Media in Retail Group (IMRG), a U.K. online retail trade organization estimates that:

Global business-to-consumer e-commerce sales will pas the 1 trillion euro (1.25 trillion USD) mark by 2013, and the total number of internet users will increase to approximately 3.5 billion from around 2.2 billion at the end of 2011.

http://www.internetretailer.com/2012/06/14/global-e-commerce-sales-will-top-125-trillion-2013

Managerial Concern Over Operating Income:

An argument against my prediction can certainly be made, storefront operating income increased exponentially in 2011, Apple's most recent 10-Q (7.25.12) states:

The Retail segment reported operating income of $1.0 billion during the first quarter of 2011 as compared to $481 million during the first quarter of 2010.

http://www.sec.gov/Archives/edgar/data/320193/000119312511010144/d10q.htm

However, these results are deceiving. Apple's strategy of it's storefront locations serving as conduits for retail traffic are not the primary reason for the exponential increase in operating income. By it's own admission, Apple states in its quarterly report (7.25.12):

The year-over-year increase in retail operating income during the first quarter of 2011 was primarily attributable to higher overall net sales resulting in more effective leverage of fixed costs.

This is direct evidence Apple is readjusting the overhead of it's storefront locations to bolster operating income. Whether or not the stores generate income is irrelevant if they cannot manage costs.

Evidence has suggested that Apple's management is concerned about storefront operating income, this became evident in August 2012, when it was reported by various media outlets (Business Insider, MacAddict.com and bgr.com) that Apple was implementing massive layoffs, budget cuts and revenue incentives for employees. Apple quickly reversed it's layoff policy, however, budget cuts and sales incentives remained.

IFOAppleStore.com, a news outlet focused on Apple storefront coverage reported:

Despite a public acknowledgement by Apple that recent retail store staffing changes were "a mistake" and have been reversed, store employees still haven't received an official explanation of the changes, and signs persist of a continuing focus on revenues and profit instead of customer satisfaction.

http://www.ifoapplestore.com/db/2012/08/27/reports-persist-of-budget-cuts-emphasis-on-revenue/

If an increase in overall operating income was largely attributable to leverage of fixed costs, and management appears to be in the process of adjusting it's storefront overhead, this is a sign that future operating income projections are a major concern among Apple executives.

Apple's exposure to storefront real estate is significant.

Apple's recent 10-Q (7.25.12) outlines it's commercial retail liabilities:

Leases for retail space are for terms ranging from five to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options. As of June 30, 2012, the Company's total future minimum lease payments under noncancelable operating leases were $4.1 billion, of which $3.0 billion related to leases for retail space.

By it's own admission (10-Q 7.25.12) Apple storefront closings or underperformance would cause Apple to:

incur substantial costs if it were to close multiple retail stores and such costs could adversely affect the Company's financial condition and operating results.

With drastic moves to reduce storefront overhead matched against the massive growth in online retail, Apple may see a significant drag on its balance sheet if it cannot further cut costs to compete with online retail.

Use this information as a trigger for a short sale on the horizon, any store closings or downsizing could be the first domino in a series of problem's with Apple's financial condition.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Themes: APPLE, REAL ESTATE, RETAIL, ONLINE RETAIL, REITS.Stocks:AAPL

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in [[AAPL]], [[BBY]] over the next 72 hours.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.