Time to sell real estate stocks?

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Author: Stires, David

IF BARRACK is right that the U.S. real estate market is on the brink of a bust, what do you do if you're knee-deep in homebuilding stocks? Or even real estate investment trusts (REITs)?

Let's start with REITs, where the outlook is generally good. The vast majority of REITs are focused on the commercial sector, which hasn't been as frothy as the housing market. If you invest in REITs through a mutual fund, as most folks do, you probably own a variety of commercial issues, from hotels to retail stores to offices. With forecasters predicting that the economy will continue growing at a 3% to 4% clip, the demand for these types of income-producing properties should remain solid.

Fund pros are particularly upbeat about hotel REITs. Star fund manager Ken Heebner has sunk more than 30% of his CGM Realty into the sector. His thinking: Hotel values are getting a boost from increased business travel. And developers in large cities are frenetically converting hotels into condos, creating a room shortage. You might also look for REIT funds that invest in Europe, a market Barrack still likes. One to consider: Alpine International Real Estate (EGLRX).

Now for the troublesome topic: homebuilding stocks. We've been optimistic. (See "Hang on to the Homebuilders" on fortune.com.) But while Barrack is most worried about condos, his doomsday scenario would have a knock-on effect on homebuilders. And there are already signs of a slowdown. Homes are on the market longer in some areas, and mortgage rates are rising. On the other hand, studies show that people buy houses as long as the 30-year mortgage rate--currently 6%--stays below 8%. Population growth, fueled in part by immigration, is boosting demand for new homes. Plus, environmental and zoning regulations are tightening the supply of land. Those trends are intact. Finally, homebuilding stocks remain cheap. As a group, they trade for just eight times the previous 12 months' earnings. That's about 25% below their average P/E of 11 during the past 20 years.

With this much uncertainty, playing it safe seems smart. We wouldn't put more money into housing stocks just now. And for investors who have loaded up on the builders, this might be a good time to take some profits.

GRAPH: Building boom

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By David Stires