Not Your Usual Real Estate Trusts.

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Real Estate

Portfolio manager Michael Winer's Third Avenue Real Estate Value Fund is an odd bird. It's the only mutual fund to invest primarily in Real Estate Operating Companies (REOCs) instead of Real Estate Investment Trusts (REITs), which every other real estate fund buys. The differences in their financial structures give REOCs an edge, Winer says. So far, his bet has paid off: As of May 31, his $322 million fund has the best three-year annualized return--17.85%--out of 115 real estate funds tracked by Morningstar. Personal Finance Editor Lewis Braham recently caught up with the 46-year-old Winer in his New York office to discuss his strategy.

Primarily, it's our focus. Our investment objective is long-term capital appreciation, whereas most real estate funds are seeking the dividend yield that REITs throw off. REITs usually make up only 10% to 20% of my portfolio.

Since real estate is a capital-intensive business, access to capital or the ability to retain capital is precious. REOCs are structured like any other operating company, so they can retain all of their cash flow. REITs have a special tax status, which requires them to pay out 90% of their taxable income as dividends. That gives REITs attractive yields, but it also makes it difficult for them to invest in their businesses. Thus, they have to access the capital markets, especially the equity markets, in order to grow.

Right. They're not always able to access capital, and the best time to be investing in real estate is not when the markets are hot and REIT stocks are high. The best time to be investing is when things are looking a little bleak and there are more opportunities. REOCs are able to be more opportunistic at those times because of their ability to retain cash.

I am still finding values, but they're not as good as they were three years ago. Back in 1998 and 1999, we could find stocks trading at a 25% to 30% discount to their underlying real estate value. Today, my portfolio is trading at a 10% or 15% discount. The REIT market, by contrast, is trading in a range between a 5% discount and 5% premium. That isn't cheap, but it's still much better than in 1997, when REITs were trading at 30% premiums and were grossly overpriced.

When the economy enters a recession, the effects aren't felt by commercial landlords immediately. There's a lag to the downturn because tenants of retail, office, and industrial real estate tend to have long-term leases, 3 years to 10 years. Provided the tenants don't go bankrupt, they're still going to pay rent, whether they are as profitable as they were before or not. That said, as leases expire, there will be vacancies as companies decide not to renew their leases. So there are currently higher vacancy rates in every property sector, and rents have fallen, but those are temporary effects. People should invest in real estate for the long term.

We did have a substantial portion of the fund's assets invested in homebuilder stocks until about a year ago. We probably exited too soon, but at that time, I thought homebuilder stock prices were at a level that couldn't be sustained. We were entering a recession, yet the companies were selling more homes than they had before the slowdown.

A lot of that growth stemmed from the interest-rate cuts last year. Mortgage rates are now at or near historic lows, so it is relatively inexpensive to buy a home. But if we see some spikes in those rates, I think the run will be over.

Copyright 2002 The McGraw-Hill Companies, Inc.

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