Stock Strength Continues in Lodging Sector - Buy on United Dominion (UDR) & Inkeepers USA Trust (KPA)

As Q2 earnings continue this week, we have checked in with real estate investment trust (REIT) senior analyst Greg Sukenik, who will let us know his take on which areas of real estate might still have some good investment options. Though many have turned bearish on the housing market in general, several of your REITs are still Buy-rated. Which types of companies are expected to perform well? We are still bullish on the lodging and apartment sectors. Lodging companies continue to post strong quarterly results, as room rates and occupancies are on the rise. We also note, that while supply has picked up, new hotel deliveries are still below historical levels and we expect hotel owners to continue to post solid results throughout the year. The lodging companies in the Zacks' coverage universe are attractively valued compared to other property types, and feel this sector should continue to outperform in 2006. Apartment companies are expensive, as improving industry fundamentals has caused investors to push up shares in Apartment REITs. On a total return basis, Apartment REITs have outperformed all other sectors so far in 2006. Despite the run up, we still think there are some good values in this sector. After several years of weak results, apartment owners have regained pricing power. Rents in many top markets are increasing at a healthy pace, and we expect this to continue through the next few quarters. As interest rates are increasing and the for sale housing market is in a decline, apartment owners will continue to benefit. In the 1st quarter of this year, most apartment companies reported a significant decline in resident turnover due to home purchase. On the flip-side, what area of REITs should investors be most wary of? Retail continues to perform well. Mall and strip center owners are still able to increase rents, as demand from retailers has not diminished. Although, we think consumer spending could be due for a slowdown. Higher energy prices and stagnant to falling home values will inevitably affect spending. This negative effect is usually delayed, and we expect to see reduced consumer spending show up in Retail REITs' results toward the end of 2006 and early 2007. Office fundamentals, while improving, are still weak in many markets. Landlords are still reporting significant rent decreases and concessions on new leases. Although, some markets, such as New York, D.C, and parts of California should perform better as supply demand fundamentals are improving. Many Southern markets, like Dallas and Atlanta, still have high vacancies and cutthroat competition for tenants. We think the office recovery will be uneven and companies with asset concentrations in the south and slower growth Midwest will still have a challenging operating environment. How are speculations on the Fed funds rate having an impact on companies in your coverage? The gradual increase in interest rates should eventually have a negative effect on REITs. Although another 25 bps increase would not change our outlook in general. Historically, higher interest rates have pushed REIT share prices down, as many investors buy REITs for income. Although, the Fed indicated that it might be done raising rates for now, and rates are still very low on a historical basis. The 10-year treasury is now over 5%, while the average yield of equity REITs in the Zacks' coverage universe is just over 4%. Historically, REIT yields have been higher than treasuries. REITs have become less attractive to the income-oriented investor as share prices are still at historical highs. We expect REIT yields to increase in the near term, as better fundamentals should result in dividend increases at better positioned companies. What are your main Buy- and Sell-recommended stocks at this time? We have a Buy on United Dominion (UDR), an apartment REIT with assets concentrated in the Southeast and Southwestern U.S. UDR continues to report strong numbers, and the company is still valued well below more expensive peers. We expect UDR to close the valuation gap with many of its peers in the next twelve months. We also have a Buy on Inkeepers USA Trust (KPA), a small lodging REIT with assets in good markets throughout the country. Inkeepers had a solid 1st quarter, and we expect a strong 2006. The company should grow earnings by about 20% compared to last year. The company is attractively valued on an NAV (net asset value) and price/FFO basis. KPA currently trades slightly under our NAV estimate. Looking toward the end of 2006, where do you see the real estate market positioned? Many REITs have gone private in the past year, and we think this trend will continue throughout the year. Companies that are not being valued appropriately, in managements view, in the public marketplace will opt for higher valuations from institutional buyers. There is still high interest in quality commercial real estate from institutional investors. While the housing market is slowing, commercial real estate values are still at all-time highs. We have not seen pricing come down in most property types. We would expect cap rates to slightly increase as interest rates rise, although there has not been much evidence of this so far. Although, pricing for apartment properties has fallen, as condo conversions has slowed in many once-hot markets. We favor companies that have a history of consistent dividend increases. As REIT share prices are still hovering near all time highs, we think much of the gain from REITs in the next six months will come from dividends and not share appreciation. Look for companies that are producing plenty of free cash flow with low payout ratios, as this is the precursor for dividend increases. Greg Sukenik is a senior analyst covering REITs for Zacks Equity Research. Courtesy: Zacks.com | Blog Home| VitalStocks Home