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All three factors appear to be changing, and this will greatly reduce the relative financial incentive to become a homeowner. As a result, the competition from home ownership should diminish, perhaps considerably. This is especially timely as the leading edge of the "echo boom" generation moves into the first-time housing market. Ownership Affordability Future strong home price appreciation is a benefit because it creates windfall capital gains for owners. But strong home price appreciation (relative to income) in the recent past is a negative because it reduces the amount of house a household can afford. That is the situation we find ourselves in. Over the last five years, house prices have risen considerably faster than incomes, inflation and most other asset prices. But those rising prices were more than offset by low and falling mortgage rates for most of that time, which pushed homeownership affordability measures to their highest levels in 30 years. Things began to change after 2003, when rates not only stopped falling, but actually began to rise. Affordability has now fallen to its lowest level in more than 13 years. Despite falling affordability, single-family (and condo) home sales continued to rise, setting an all-time record in 2005. This was due, in large part, to ever greater house price appreciation, which led potential buyers to expect even greater future capital gains. The total cost of ownership -- such as mortgage payment, taxes and maintenance -- includes the gains from tax savings and price appreciation. Double-digit appreciation rates have meant that homeowner housing has been better than free; owners in effect have been getting "paid" for owning a home. But if the appreciation rate should drop back to a more normal rate of about 4%, the total cost figure jumps from an all-time low of negative $6,500 to a record high of more than $12,350. And if house prices are actually flat for a year, the total cost skyrockets to more than $20,500. This analysis strongly suggests that strong home ownership demand can continue only as long as buyers expect price appreciation to remain far higher than the historical average. Fortunately for apartment firms, housing analysts are virtually unanimous in forecasting the opposite -- a return to traditional rates of appreciation, or less. Rent vs. Buy Comparisons There are other ways of judging how much competition apartment owners face from home ownership. The simplest may be a direct comparison of the respective monthly payments. Specifically, we compare the median street rent on apartments to the monthly cost of a mortgage plus property taxes on the median priced house. From about 2000 through early 2004, it cost, on average, $315 a month less to rent than to own. Although this figure bounced around somewhat over this time frame, there was no real trend. Since early 2004, however, the advantage to renting has grown rapidly, averaging $480 per month. The most recent figure - a staggering $636 - is the highest ever. Clearly, those families who are buying houses today are doing so despite the fact that their monthly costs are much higher than if they rented. To be sure, this is a national trend that is not replicated everywhere. Over the last five years, metro areas have differed not only in their home price appreciation, but also in their rent changes. Of the 265 metro areas in the Office of Federal Housing Enterprise Oversight home price index, home prices more than doubled in 33 of them. While no metro areas suffered average price declines over this time, prices increased less than overall inflation in two areas, and in 20 areas the average price increased less than 20% (a compound annual rate of 3.7%). As a result, some areas have seen the renting advantage increase sharply, while others have seen more modest growth in the advantage. There are even a few metro areas where the renting advantage has actually slipped a bit. The renting advantage is generally smaller in traditionally lower housing cost areas such as Atlanta and Houston. The sizable renting advantage in higher cost housing markets may not be a surprise, although the size of the advantage in Los Angeles, at over $2,000, may be. Going forward, this comparison should be affected as much by the size of rent gains as by house price appreciation.
In the last 18 months or so, large investors like pension funds, real estate investment trusts and private companies have been expanding their holdings in medical office buildings. "Three years ago, it was probably not as hot a niche as it is today," said Dale Sperling, chief executive of Unico Properties of Seattle, which owns and operates six million square feet of office space on the West Coast. The company started investing in medical office buildings in earnest more than a year ago by buying part of a Tacoma, Wash., medical campus for $10.8 million. But as Mr. Sperling and other investors have found, the medical market is not necessarily an easy niche to break into. For one thing, it is not cheap. The average price per square foot is $248, up from $142 in 2002, according to Real Capital Analytics, a research firm, and as a result the initial yields [capitalization rates] have dropped to around 7% from more than 9% just three years ago. Finding the right properties — those on or close to hospital campuses are generally the most desirable — can be difficult. Purchases often require extensive research, because medical offices need special plumbing, electrical wiring and ventilation for their expensive equipment. And regulatory changes — like those related to Medicare and Medicaid reimbursements — could add layers of complexity that affect how buildings operate financially. Still, the big players remain confident that the medical office building sector will continue to grow. Graying baby boomers are requiring more health care, and demand has climbed for outpatient facilities, especially as both insurers and government agencies push doctors to perform lower-risk procedures outside hospital settings. Hospitals looking for revenue to invest in new technology have been selling more of their real estate or forming ventures to operate surgery centers and outpatient services within existing facilities or at satellite sites. Laws intended to prevent doctors from referring Medicare and Medicaid patients to health providers in which they have a financial interest have provided another reason for hospitals to remove themselves from the real estate business. (Under the so-called Stark laws, hospitals must lease space at fair market rates.) Medical buildings tend to have a stable tenant base. Doctors tend to have longer leases than occupants of traditional office buildings — eight years on average, versus three to five — and have renewal rates of 90% or higher, according to building owners. Many sign "triple net" leases, in which they agree to pay operating expenses like property taxes and insurance premiums. "When doctors move into one of our buildings, they just stay there for their whole practice lives," said Robert Rosenthal, president of Pacific Medical Buildings in San Diego, noting that they typically spend more money on finishes like high-end carpeting and wood cabinets. "Although doctors are demanding, they're pretty good tenants. They pay rent on time, have good credit ratings and a low rate of business failures." Doctors generally prefer to stay put in order to retain patients, and many building owners will offer them equity interests as an added incentive to stick around. Mr. Rosenthal, who has been involved in medical real estate for 35 years, says his tenants are choosing larger equity stakes these days. In the last 8 to 10 years, he said, "the amount of participation has been very low, usually, on average, one to two tenants in each building, and they would come in for $50,000 to $100,000, but lately we've gotten much more interest and much larger investments." "Now they're in the $500,000 range," he added. Outside investors can also acquire stakes in medical office buildings; the minimum investments generally range from $50,000 to $250,000. "In a typical project, one-third of the equity is provided by principals of the company and two-thirds from our private investors," Mr. Rosenthal said. He says the biggest problem is accommodating all his investors. "We have a lot more money chasing fewer projects," he said. Mr. Sperling says his strategy is to approach the hospitals and health care systems and persuade them to sell property or take in a partner. Unico closed five such deals last year. "Our success rate is high," he said. "About a third who we sit down with agree to transact a deal." Investors in medical office buildings share in the cash flow generated from rents, but they also stand to profit handsomely when the building, which often appreciates in value over the years, is eventually sold or its mortgage refinanced and built-up equity returned to those holding stakes. Some individual investors with deep pockets are opting to buy their own buildings or form small partnerships, while others are buying, and often renting out, office condos. Those with less to spend, or perhaps less desire to be landlords, can invest in REITs. Fourteen publicly traded REIT's specialize in health care real estate. Among them are Health Care Property Investors, Ventas and Cogdell Spencer [CSA], which just two weeks ago paid nearly $40 million for a 171,500-square-foot building and parking deck on the campus of Methodist Hospital in Indianapolis. The overall sector is up 6% so far this year. There are also unlisted health care REIT's like CNL Retirement Properties. Stephen Coyle, the chief investment strategist for Citigroup Property Investors, is generally bullish on the sector. "Medical spending is a huge part of our national economy," he said, though he cautions that location is a key to success. "More than anything else they need to be near a good hospital."
Archstone-Smith had about $1.3 billion in apartment projects under construction at the end of the fourth quarter -- more than double the amount it spent on projects under construction three years ago -- with nearly all of it concentrated in a few coastal cities. Part of Archstone-Smith's strategy is to target areas such as Boston, New York and Southern California, where there is a high cost of homeownership and barriers to competition, such as a shortage of developable land and an often-lengthy permitting process. "It's hard to find those characteristics in a market that isn't coastal," says R. Scot Sellers, chief executive of the Colorado-based REIT. Bryce Blair, chief executive of AvalonBay, says the apartment REIT started expanding its development pipeline about three years ago, when the national apartment market was relatively weak and there was less competition for developable land. At the end of last year, AvalonBay had about $1 billion in apartments under construction -- most of them on the coast. "It's been a big part of our strategy forever," Mr. Blair says of concentrating on the coasts. "It is becoming more in vogue today." During the mid-1990s, apartment developers built many apartments in cities such as Dallas and Atlanta, where job growth was producing a new pool of renters, says Robert Stevenson, a REIT analyst at Morgan Stanley. But those cities have more available land, pose fewer barriers to entry for developers and can be prone to overbuilding. By the late 1990s, many apartment developers were building more along the coasts, where the booming economy created jobs and landlords could charge sizable rent increases, Mr. Stevenson says. But the technology-sector collapse in late 2000 and the cutbacks in financial services hurt rental-apartment markets in Northern California, Boston and New York. Meanwhile, low interest-rate mortgages started siphoning would-be renters into home ownership. Over the past year or so, apartment fundamentals have improved, helped by increasing demand and a curtailing of supply of rental units that have been converted into for-sale condominiums. According to Boston-based Property & Portfolio Research, the average vacancy rate in the largest U.S. markets was 6.2% at the end of last year -- compared with a rate of 7.2% at the end of 2004. With an improving balance of apartment supply and demand, rents also have been ticking up in many markets. According to Property & Portfolio Research, average monthly rents increased by about 2.4% to $1,361 last year. It is unclear whether the improving apartment fundamentals will continue when much of the new supply is ready to rent. Many of the new apartments are scheduled to come on line in 2007 and 2008. Still, Mr. Sellers sees long-term advantages to building in the prime coastal cities. He says there is room for substantial rent growth in cities, where the cost of owning a home is greater than renting an apartment. And rising interest rates may put home ownership even further out of reach. "Rents have to go up," Mr. Sellers says. "They are so cheap relative to home prices." Not every apartment REIT buys the bicoastal approach. United Dominion is teaming with local developers to develop new apartments not only in coastal areas such as Southern California and Washington, D.C., but in landlocked cities such as Dallas and Phoenix. Standard & Poor's on Tuesday said it will add two real estate investment trusts, Boston Properties and Kimco Realty to its flagship Standard & Poor's 500. Realty Income (O) announced that a public offering of 5,200,000 shares of O's common stock has been priced at $24.39 per share and is expected to close on March 29, 2006. Gross proceeds from the offering will be approximately $126.8 million. Dividend Changes: On 3-23 Bedford Property announced that its Board has declared a dividend of $0.21 per share for Q1-06, down from $0.51 in Q4. On 3-15 Realty Income [O] announced an increase in the monthly dividend to $0.116875 per share from $0.11625 per share. On 3-16 EastGroup Properties (EGP) announced a 1.0% increase in its quarterly dividend, raising it to $.49 per share from $.485 per share. On 3-16 United Dominion [UDR] announced a regular quarterly dividend for Q1-06 of $0.3125/share. This represents a 4.2% increase over the same period last year. On 3-16 Corporate Office Properties [OFC] announced a quarterly dividend of $0.28/share for Q1-06. On 3-06 Equity Inns (ENN) boosted its common stock dividend by 2 cents to 19 cents. On 3-01 Ramco-Gershenson (RPT) boosted its dividend 2.3%, and authorized a $15 million share repurchase program. RPT said it will now pay a first quarter dividend of 44.75 cents, up from a previous payment of 43.75 cents. On 3-10 Janet Morrissey of the Dow Jones Newswires reported that "A few hedge funds grabbed a significant stake in MLS, becoming the latest to express interest in acquiring the distressed company. An investor group comprised of hedge funds Stark International, Stark Trading and Shepherd Investments International snapped up a 6.4% stake in Mills, according to a 13D filing submitted to the SEC on March 8. " On 3-09 Highland Hospitality announced that it has priced a public offering of 7,300,000 shares of its common stock at a price of $12.35 per share. The offering is expected to close on March 14, 2006. On 3-08 DiamondRock Hospitality announced that it has filed a registration statement to sell 14.0 million shares of its common stock in a public offering. On 3-06 CarrAmerica announced that it has signed a definitive merger agreement to be acquired by an affiliate of The Blackstone Group. Blackstone will acquire all of the outstanding common stock of CarrAmerica for $44.75 per share in cash. The purchase price per share represents an 18.4% premium over CarrAmerica's closing stock price on February 16, 2006, the date prior to published reports regarding a potential acquisition of CarrAmerica. On 3-06 Bedford (BED) reported Q4 net income of $19.1 million, or $1.23 share, down from $67.9 million, or $4.31 a share in the year-ago period. FFO 40 cents a share from 33 cents a share a year earlier. On 3-03 news that Cablevision Systems has agreed to demolish New York's Madison Square Garden and rebuild it one block west of its current site is expected to be a huge windfall for Vornado (VNO). Merrill Lynch analyst Steve Sakwa estimates the redevelopment of the old MSG and nearby land parcels owned by Vornado could support more than 7 million square feet of office and residential buildings. Sakwa estimates the MSG reconstruction transaction could add between $4 and $9 a share to Vornado's net asset value, given the potential development opportunities. He reiterated his buy rating on the company and raised his price target to $99 from $93. Hersha Hospitality (HT) posted a wider fourth-quarter loss due to the issuance of preferred stock and increased depreciation expense from growth in the company's hotel portfolio. HT said its fourth-quarter loss was $3.2 million, or 15 cents a share, after preferred distributions of $1.2 million. The year-ago loss was $787,000, or 4 cents a share. Adjusted funds from operations increased to $2.8 million, or 12 cents a share, from $1.55 million, or 7 cents a share, a year ago. Fourth-quarter revenue grew 70% to $22 million from $13 million, driven by growth in room revenue and acquisitions of hotels. When CarrAmerica earlier this week announced a buyout by New York investment firm Blackstone Group, it became the 14th REIT to go private since January 2004. There were 197 REITs in the U.S. at the end of last year, according to the NAREIT, but that is down from a peak of 226 in 1994. (Christine Haughney, WSJ 3-09) On 3-01 Wachovia Cuts Weingarten To Underperform From Market Perform. On 3-09 Deutsche Securities Initiated coverage on OHI at Buy. On 3-07 AG Edwards Downgraded HR to Buy from Hold. On 3-16 AG Edwards Downgraded HME from Buy to Hold. On 3-17 Citigroup Cuts MLS To Sell From Hold. On 3-22 Analyst David Fick of Stifel Nicolaus & Company initiates coverage of Realty Income [O] with a "hold" rating. In a research note published this morning, the analyst mentions that the company has a triple-net lease portfolio and is expected to achieve earnings growth through acquisitions and rent hikes in the near future. On 3-23 AG Edwards Initiated FPO at Buy. On 2-02 Keybanc Cut Camden to Hold From Aggressive Buy, Stifel Nicolaus Raised Health Care REIT to Buy From Hold, and Raised Healthcare Realty to Buy From Hold. On 2-01 Banc Of America Cut Health Care REIT to Sell From Neutral and Cut Ventas to Neutral From Buy. Deutsche Bank Raised Kilroy to Buy From Hold. On 2-03 Merrill Cut Archstone-Smith to Neutral From Buy. On 2-08 Prudential Cuts Health Care REIT to Neutral From Overweight. On 2-10 Keybanc Cuts Kite Realty to Hold From Buy and Merrill Upped Nationwide Health Properties to Buy From Neutral. On 2-13 Credit Suisse Cut Digital Realty To Underperform from Neutral, and Cut Maguire to Underperform From Neutral. On 2-13 UBS Raised Kimco to Buy From Neutral, Raised Regency Centers to Neutral From Reduce and Raised Simon Property to Buy From Neutral. On 2-13 Banc Of America Cut Brookfield to Neutral From Buy, Wachovia Cut Brookfield to Market Perform From Outperform to hold. Desjardins Lowered Brookfield to Hold From Buy. On 2-14 Harris Nesbitt Cut Nationwide Health to Underperform and Raised Healthcare Realty to Outperform. On 2-14 Merrill Raised Kimco to Buy From Neutral. On 2-15 Stifel Nicolaus Raised United Dominion to Buy From Hold. On 2-22 Prudential Downgraded GGP from Overweight to Neutral. On 2-27 JP Morgan Downgraded WRI from Neutral to Underweight, BB&T Capital Markets Downgraded EQY from Buy to Hold, Wachovia upped AIV to Outperform, and JP Morgan Cut Brandywine to Neutral From Overweight. Update: Fifth Experiment in Stock Picking 3-31-06 The new year has started, and my portfolio still lacks the 10% weighting in hospitality [AHT and SHO are candidates], the 12% weighting in apartments [GCT? or buying of AVB/BRE/ESS - but at such low yields?] and the 6% weighting in health care [with purchases of VTR] that I want. And add industrial FPO to the menu. But with prices at an all time high, it is no time to buy. But it might be a good time to lighten up on offices [and sell CRE or some VNO?]. GGP is up 25% since my purchase in August - its valuation scares me. And I want to dump MLS. The NAREIT index is 25% weighted in office and industrial, but this portfolio is 42% in those categories. The NAREIT index is 25% weighted in retail, mall and free-standing, but this portfolio is 34% in those categories. So I am uncomfortable with this portfolio's weighting and the valuations of highly weighted ARE, GGP, OFC and VNO.
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