Pairing Up on REITs

The Conference Board's Consumer Confidence Index recently reported an all-time low for December. Home prices according to the Standard & Poors/Case-Shiller Index also just logged a record-breaking performance to the downside. Unemployment continues to march upward.

The market knows this already and has done a rather efficient job of discounting anything that touches the consumer. Retailers, consumer discretionary companies and REITs have all been devastated.

However, the market has been somewhat inefficient in its markdown of REITs. It has treated those that rent residential apartment homes just as poorly as those that rent retail space. This presents an opportunity as the fundamentals appear better for residential REITs:

• A continuing wave of immigration and new family formation creates a continuous need for shelter.


• Displaced homeowners need to find a shelter somewhere.


• Generally speaking, the nation is overstored. From my perch on Long Island, if 50% of the stores vanished overnight, I would still have no trouble finding the goods that I need.


• Christmas is over and the first-quarter headlines will be littered with store closings and bankruptcies.


• Government-sponsored agency financing is an alternative that is predominately available to the multifamily housing sector.

Accordingly, my theme today is to go long the residential REITs and short the retail REITs.

The Longs

Essex Properties (ESS - commentary - Cramer's Take) has one of the better balance sheets among its peers. The company focuses on select West Coast communities with significant constraints on housing production. These areas tend to have lower foreclosure rates and, therefore, higher occupancy rates. The Essex portfolio currently consists of 133 properties and more than 26,000 apartments.

Avalon Bay Communities (AVB - commentary - Cramer's Take) also has one of the stronger balance sheets in the industry and boasts the highest average rental rates in the sector at $1,943. This high price point could be seen as a negative because of the recession; however, it is an opportunity to buy best-in-class real estate.

Avalon's portfolio is concentrated in markets that have a high barrier to entry -- New England (Boston, Fairfield County and New Haven), metropolitan New York (Manhattan, Long Island and New Jersey), Mid-Atlantic/Midwest (Washington, DC, and Chicago), the Pacific Northwest (Seattle) and Southern and Northern California.

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At the time of publication, Masino was long ESS, AVB and BRE and short WRI and SPG, but positions can change at any time.

Rich Masino is president of Private Investor Research and editor of The Substantial Investor. He is a private investor who manages a family long/short investment portfolio that holds numerous positions across a variety of asset classes.

Before starting Private Investor Research, Mr. Masino co-founded a telecommunications company that grew to 500,000 customers. He sold all of his interests in the company in 1998.

He holds an MBA in finance from St. John's University.