Still Finding Value in Real Estate

 | Oct 28, 2013 | 11:00 AM EDT  | Comments
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wsr

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inn

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drh

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cldt

I continue to find value in high-yield sectors that have underperformed the market over the past three or four months on the back of rising interest rates. This provides long-term value and nice entry points for income investors.

I don't find a lot of value in the overall market, as earnings growth seems to be decelerating over the past few quarters and most of the gains this year have been as the result of multiple expansions, not growing profits. Yield looks like more of a sure thing as opposed to capital appreciation.

After the quick rise over the summer, I don't see interest rates going much past the recent 3% level in 10-year Treasuries. Economic and job growth is likely to remain tepid, and the Federal Reserve is likely to remain extremely accommodative. This should keep a ceiling on rates and should buoy high-yield sectors such as energy limited partnerships and real estate investment trusts (REITs).

I have added a couple of attractive and solid-yielding REITs to my income portfolio over the past few months.

Whitestone REIT (WSR) is a fully integrated real estate company that owns, operates and redevelops Community Centered Properties, which are visibly located properties in established or developing culturally diverse neighborhoods. The REIT owns and manages about 50 Community Center Properties, including retail, office and office/flex space, with 4.5 million square feet of gross leasing area (GLA). Almost all of Whitestone's properties are located in fast-growing Texas and Arizona.

A unique aspect of this REIT is that it primarily rents smaller spaces to smaller businesses than most retail REITs. The downside is that these clients have less sturdy credit than a Macy's (M) or a Target (TGT), and in downturns that causes some clients to fold. On the upside, when the economy is growing, Whitestone can get 50% to 75% more per square foot by renting to these smaller firms than to the major retailers that drive a harder bargain.

Whitestone has raised its overall occupancy rate to 87% from 82% a few years ago as the economy has recovered. This trend should continue as long as we avoid recession and each percentage point rise in occupancy means an additional $600,000 to $700,000 of annual funds from operations.

The shares yield slightly more than 8% at its current price and the company makes monthly dividend payouts. Funds from operations are growing at a 10% pace and insiders have been net buyers of the stock in 2013. The company has a solid balance sheet and recently conducted a capital raise that will enable it to continue to expand its portfolio.

I have continued to add to my position in Summit Hotel Properties (INN). This hotel REIT focuses on upscale and upper-midscale select-service hotels on a national basis. It has about 95 hotels with more than 11,000 rooms. I have done well in the hotel space over the past year, scoring significant gains in Diamondrock Hospitality (DRH) and Chatham Lodging Trust (CLDT).

Average daily rates (ADR) and revenue per room (RevPAR) continue to increase at a nice clip across the industry as the economy slowly recovers. Summit has done a solid job in growing by making accretive acquisitions as well as improving operating performance since it came public in early 2011.

The shares yield 4.8% and I expect the payout to be raised in 2014 as FFO is projected to grow about 25% year over year in 2014 to more than $1 per share. The company has a solid balance sheet with staggered debt maturities, and I expect it to continue to improve its occupancy rate and average ADR. INN goes for just 9x forward FFO and sells just below book value.

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