One of the ongoing long-term discussions around Chez Melvin revolves around real estate. This group is probably the best reflection of the U.S. economy, and it impacts a wide range of other sectors. Certainly it plays heavily in banking, one of my favorite patches. In 2007, my curmudgeonly, options-trading friend picked up on the excesses of 2007 by observing his real estate friends. As for myself, back in 2009 I spotted the obvious under-valuations in hotels and shopping centers -- thanks to at least a rough idea that I'd had of the replacement value of commercial properties. One of the first things I do when I'm checking out a bank is to look at the type and location of its real-estate-lending portfolio.
In the aforesaid discussions, we've even talked about expanding from just stocks and bonds into property acquisition, management and brokerage. Although we have seen an improvement in many real-estate markets around the U.S., the space is nowhere near the levels it had reached in 2007: The Moody's/RCA Commercial Property Price Indices are still 23% below the pre-bust highs. If you take the red-hot apartment sector out of the mix, the composite is even further away from the highs. Sectors like suburban offices and retail properties, for instance, are still at very low levels.
If you look at residential real estate, you'll find the same picture. There are signs of improvement but, on a national level, prices are still roughly one-third lower than they were at the peak. Some of the harder-hit areas are even cheaper. At this point, housing prices are still trading at about the same level that they had done a decade ago.
For investors, one of the big problems that has developed has been in the asset-allocation trade. It is no secret that real estate is cheap, and that the models used by large funds have pushed money at the sector. When they are buying the larger, more liquid names, valuations can quickly become distorted. The use of exchange-traded funds has also caused many real estate investment trusts to become fully valued, or even overvalued, as the value of underlying properties had still been basically flat-lining. On the ground, this has somewhat thinned out real-estate opportunities for long-term investors who have no desire to own property directly.
I still see a few names that are worth our attention. We have done very well in our shopping-center REITs, but both Cedar Realty (CDR) and Kite Realty (KRG) are still at attractive valuations for long-term investors. Construction of new centers has slowed to a crawl, and we are seeing rent and occupancy rates stabilize. As for the shares, Kite trades right at tangible book value and yields a little over 4%.
Cedar has not recovered as quickly, and this stock is still very cheap at just 60% of tangible book value. The firm has sold off properties it had considered to be noncore, and it has also lowered its financing costs in the past year. It's focusing on grocery-store-anchored shopping centers in the Northeast, which strikes me as a winning long-term strategy, and I think long-term investors will be handsomely rewarded. The shares yield 3.8%, so you get paid to wait for further improvements.
I am still a big fan of Brookfield Office Properties (BPO), as well. As is well known to REIT investors, the lease in Brookfield's Lower Manhattan properties is set to roll over at the end of this year, and this issue has capped the stock price for now. Namely, 3.1 million square feet in the World Financial Center are scheduled to expire in October.
While that is a concern, Brookfield has made progress filling the space. Barring the lease rollover, this is one of the best collections of premier office properties in the world -- and buying the shares at just 80% of tangible book value strikes me a solid idea for long-term investors. In addition to the top-tier properties, Brookfield owns more than 17 million square feet of projects under development. This should add substantial value over the next decade.
So, in all, the leasing concerns at World Financial Center have created an opportunity to buy a world-class portfolio of office buildings at a discount. The dividend yield at this point is about 3.3%.
While real estate is still cheap on a historical and replacement-value basis, many publicly traded real-estate vehicles have seen their value artificially inflated by the grand asset allocation trade in the markets. However, a little digging and rock-kicking can help you find real-estate investments that are still very attractive on an asset-value basis for long-term investors.