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Checking In on Real Estate Funds

It's a natural time to put a spotlight on funds in the real estate sector.

Foreclosures abound, as homeowners walk away from properties whose values have imploded from their purchase price. The Mortgage Bankers Association reported year-end 2007 foreclosures at an all-time high and late payments at a 23-year high.

Real estate investment trusts, or REITs, and real-estate-focused financial firms that borrow money to buy income producing properties or mortgage-backed securities are teaching a risk-averse public the meaning of the term "margin call."

Carlyle Capital borrowed $32 for every dollar of equity capital to buy $22 billion in mortgage debt. When the value of its collateral went south, its Wall Street bankers issues a margin call to put up more money.

The failure to meet margin calls forces the liquidation of potentially illiquid mortgage securities. The fear is that this may further push down prices, triggering more margin calls and forced sales and leaving nobody willing to fund real estate purchases.

The worst-performing fund this week, iShares FTSE NAREIT Mortgage REITs Index Fund (REM), amputated 28.57% of shareholder value in the five trading days ending March 6. The fund's 26.51% holding in Annaly Capital Management (NLY) dropped 23.99% on lower estimates of this mortgage REIT's book value.

Down 83.09%, fund holding Thornburg Mortgage (TMA) failed to satisfy a $28 million margin call, defaulted on lending agreements, and risks bankruptcy. Another holding, Deerfield Capital (DFR), crashed 70.59% after being squeezed into the fire sale of $1.3 billion in residential bonds at a loss of $152.9 million.

The iShares DJ US Home Construction Index Fund (ITB), off 14.25%, is the second-worst real estate fund this week. Every single holding fell for the period, with WCI Communities (WCI) at negative 26.56%, Meritage Homes (MTH) at negative 19.49%, Hovnanian Enterprises (HOV) at negative 18.61%, and Pulte Homes (PHM) at negative 17.91% leading the way down.

Even after laying off 575 workers in November, WCI Communities warned that its fourth-quarter pretax loss could hit $460 million.

Worst-Performing Real Estate Funds
Ranked by returns for the week ending March 6
Fund Ticker Rating Fund Type 1 Week Total Return
iShares FTSE NAREIT Mortgage REITs Index Fund REM U ETF -28.57%
iShares DJ US Home Construction Index Fund ITB E- ETF -14.25%
Fidelity Select Home Finance Portfolio FSVLX E- Open-End -13.68%
Ultra Real Estate ProShares URE E- ETF -13.49%
FocusShares ISE Homebuilders Index Fund SAW U ETF -13.21%
SPDR S&P Homebuilders ETF XHB E- ETF -13.07%
ING Clarion Global Real Estate Income Fund IGR C+ Closed-End -11.60%
Neuberger Berman Real Estate Sec Inc Fund NRO C Closed-End -10.61%
Nuveen Real Estate Income Fund JRS D+ Closed-End -10.29%
ProFunds Real Estate UltraSector ProFund REPSX E- Open-End -10.04%
Source: Bloomberg, Read this for an explanation of our ratings, click here

The best two funds short the members of the Dow Jones U.S. Real Estate Index. The UltraShort Real Estate ProShares (SRS) returned 14.25% using 200% negative leverage. That's twice as much as 6.99% earned by the unleveraged ProFunds Short Real Estate ProFund (SRPIX).

Holdings in Thornburg Mortgage, iStar Financial (SFI) (down 30.76%) and RAIT Financial Trust (RAS) (down 28.48%) contributed to the outsized performance of these funds.

The RMR Asia Pacific Real Estate Fund (RAP) stayed above water. Though it's down for the year, it gained 0.54% this week by staying far enough away from the U.S. real estate market.

Also not doing too poorly this week was the Cohen & Steers European Realty Shares (EURAX), which narrowly lost 0.23%. One of its holdings, Unibail-Rodamco, added 4.09% in the period after winning approval to develop a new shopping mall in Stockholm, Sweden.

Best Performing Real Estate Funds
Ranked by returns for the week ending March 6
Fund Ticker Rating Fund Type 1 Week Total Return
UltraShort Real Estate ProShares SRS C- ETF 14.25%
ProFunds Short Real Estate ProFund SRPIX U Open-End 6.99%
RMR Asia Pacific Real Estate Fund RAP E- Closed-End 0.54%
Cohen & Steers European Realty Shares Inc EURAX U Open-End -0.23%
Adelante Shares RE Value Exchange-Traded Fund AVU U ETF -0.45%
Adelante Shares RE Kings Exchange-Traded Fund AKB U ETF -0.49%
iShares FTSE EPRA/NAREIT Europe Index Fund IFEU U ETF -0.54%
iShares FTSE NAREIT Real Estate 50 Index Fund FTY U ETF -1.58%
Morgan Stanley Inst - International Real Estate Portfolio MSUAX C- Open-End -1.94%
First Trust S&P REIT Index Fund FRI U ETF -2.21%
Source: Bloomberg, Read this for an explanation of our ratings, click here

David Seiders, the Chief Economist for the National Association of Home Builders, made the case this week that to save the U.S. economy from recession, we must first save the homebuilding industry. His organization is asking Congress for $15,000 tax breaks for new home buyers, in order to promote purchases.

In addition, home builders such as Pulte and KB Home (KBH) are hoping the transition to environmentally friendly "green" homes may help revitalize the industry. However, they have yet to see a significant difference in sales.

Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by TheStreet.com, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.

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