REITs to Continue Their Run?

If the slump in residential housing is scaring you away from investing in real estate investment trusts, Rich Moore has some advice for you. "Single-family housing has absolutely nothing to do with commercial real estate," says Moore, who analyzes REITs at RBC Capital Markets. What drives commercial property, he says, are such factors as employment growth, supply and demand for space, consumer demand, and the influx of institutional money. Moore thinks all these fundamentals look good, portending yet another strong year for REITs in 2007.

Take consumer demand. "Every year there is concern about consumption, but the consumer never really slows down," says Moore. Demand for space is strong at the large shopping malls; tenant waiting lists are common. That’s one reason Moore likes Simon Property Group (symbol SPG), the nation’s largest owner and operator of shopping malls. "It’s important to be big in retail," he says, "because then you deal with the same tenants across the country." Mall leases typically run seven to ten years, and Simon is able to jack up rents by something like 40% upon lease expiration.

Moore’s pick in the apartment REIT space is AvalonBay Communities (AVB), which has a number of projects under construction. He likes the location of Avalon’s high-quality properties, principally on the coasts in areas with strong demand. Because of high inflation in housing prices, there is still a large gap between the cost of purchasing and renting housing in these areas.

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The market for office space is a bit of a dichotomy: extremely strong demand and robust rentals in New York City, Seattle and other coastal cities, but weakness in urban centers in the heartland. Moore favors Digital Realty Trust (DLR), a lesser-known REIT in the office sector. Digital operates technology data centers for corporations, usually on the outskirts of cities, in areas typically populated by warehouses. The real estate may be less expensive, but Moore says Digital is able to charge high rents for the space because back-up data centers are in great demand by banks and other corporations.

Moore is aware that REITs have outshined other stocks for seven straight years. Yet he doesn’t think a correction is in the cards. "It’s a great time to buy real estate stocks probably for the next five years," he says.

Simon closed at $101.81 on January 9, up 2.1% for the day. Avalon finished at $33.85, up almost 1%. And Digital ended the session at $34.04, virtually unchanged.