The TSC Streetside Chat: Carl Tash Looks Ahead on Real Estate

Carl Tash has seen the world of real estate from all sides, from private development to REITs. Now, as the principal and portfolio manager at Cliffwood Partners, a Los Angeles real estate investment firm, Tash uses his decades of experience to sort through public real estate companies, looking for overlooked values as well as those REITs and real estate operating companies that appear overvalued.

After two years of REITs outperforming the broader market, Tash voices caution about their future performance. He cites current valuation in an environment of weak fundamentals, and the possibility that investors who profited from the recent runup in REITs will pocket the profits and invest elsewhere. Still, Tash has a knack for finding value in just about any market, and he highlighted his current investment ideas with TheStreet.com contributing editor Christopher Edmonds.

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TheStreet.com: Real estate investment trusts, or REITs, have outperformed the broader market for the past two years. And with the S&P 500 relatively flat in the first quarter, REITs are doing it again, gaining nearly 9%. Why are REITs doing so well?

Carl Tash: It's all about money flows. In a difficult market, dividend yields have attracted investors to REITs. At the same time, fundamentals have deteriorated for most property sectors over the last six to nine months. But relative to technology, the fundamentals aren't terrible. And investors take comfort in the "safe" dividends and, frankly, aren't doing a lot of research into fundamentals at this point.

TheStreet.com: What impact has the economic slowdown had on real estate and REITs?

Carl Tash:: Every property sector is a little different. In hotels we saw the impact immediately as demand cratered. Hotels are a good, almost immediate, economic barometer.

Apartments have been affected in two ways. First, declining employment had an impact on occupancy and rents. Second, interest rates and affordable housing prices helped increase home ownership at the expense of rentals.

Fundamentals in office and industrial properties have deteriorated as corporate earnings have declined, pushing occupancy and rents lower. But it takes time to burn off old leases. Yet office markets will continue to feel the challenge from the recent slowdown.

One sector that many think has been spared the impact of the slowdown is regional malls. However, investors may be surprised. Leasing strength is weakening, which is not a good sign.

TheStreet.com: Given those views, where are you focused today?

Carl Tash: I'd start with apartments and my variant perceptions. Most analysts are negative on the apartment sector, but we think "B-class" apartments are one of the safest REIT investments today. A company with a good balance sheet and good properties should do fine. The impact of the housing boom and unemployment is factored into estimates. We still like companies such as Essex Property Trust(ESS Quote) and United Dominion Realty Trust(UDR Quote). And even Equity Residential Properties Trust(EQR Quote), while trading slightly above its asset value, is a fairly safe name.

We are still cautious on "A-class" apartments, companies like Post Properties(PPS Quote) and Avalon Bay(AVB Quote). That's not to say they aren't good companies; we are just nervous about their product mix.

On the retail front we don't like the regional mall business. Almost all analysts have taken comfort that the fourth-quarter results were so good that they forget that the mall business is very seasonal, especially when it comes to leasing. Tenants usually don't move until the first quarter, when inventories are low, and the mall business doesn't show its true colors until the second quarter. And the real question is how much space companies like Gap(GAP Quote) and The Limited(LTD Quote) are going to lease this year vs. last year. There will be a lot of space out there.

In short, the leasing power is going to be in the hands of tenants, not landlords. That will pressure companies that have had big moves, including Mills(MLS Quote), CBL & Associates(CBL Quote) and Macerich(MAC Quote).

We are also not big fans of big-box retail. There are only so many Kohl's(KSS Quote) and Targets(TGT Quote) to go around, and plenty of Service Merchandise and Kmart spaces to fill. A lot more tenants are leaving boxes than filling boxes. However, we do like a company like Pan Pacific(PNP Quote), a grocery-anchored company that blocks and tackles really well. We wish we could find more of those companies in the REIT universe.

In the office and industrial space we are focused on opportunistic companies with solid balance sheets. We like Vornado Realty Trust(VNO Quote) and Catellus(CDX Quote). We are not big fans of companies trading at meaningful premiums to net asset value. CenterPoint Properties(CNT Quote) and Colonial Properties Trust(CLP Quote) are examples. Over time those values will become hard to justify.

Hotels still face a big demand issue. We think people are overly optimistic about a sharp demand recovery we don't think will materialize, at least not as quickly as many analysts are anticipating.

TheStreet.com: Is there one issue that REIT investors need to focus on that doesn't get attention from analysts?

Carl Tash: Yes. Capex, or the capital expenditures required to lease space in today's environment. Nobody is focused on what it is costing a REIT to release space today. If there is one thing I hear from private real estate companies more often than anything else, it is surprise at how many uneconomical leases REITs are signing in today's market.

Moreover, analysts aren't focused on the capex number because it has little impact on the funds-from-operations calculation. That's OK when money is plentiful for these companies, but if that changes, capex could be the downfall of a number of REITs.

TheStreet.com: Where do REITs go from here? Recent secondary offerings and new fund offerings are similar to those in 1997-98, the last time REITs peaked. Are you fearful the current run in REITs is about to end?

Carl Tash: Currently valuations are dictated by money flows, and analysts are struggling to write reports to justify REIT valuations above net asset value. To us, that seems a lot like 1997 revisited. You have to use tortured logic to justify stock prices that are significantly above a REIT's net asset value.

And when money keeps flowing in, investors don't focus on risk. There are a number of smaller REITs that are trading at a 30%-40% premium to our calculation of their net asset value. That only continues until the last dollar is in the sector. We are close to that point, and then fundamentals will begin to matter.

That said, none of us are smart enough to know exactly when that will happen. But in a market like this, you want to be focused on stocks you want to own when the money flows stop. After all, trees don't grow to the sky.