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REITs to Rise as Economy Rebounds

Fidelity's Steve Buller says REITS will gain as companies expand and property values rise in the recovering economy.

BOSTON (TheStreet) -- Fidelity Investments manager Steve Buller says real estate investment trusts, or REITS, will gain as companies expand and property values rise in the recovering economy.

Buller manages the $3.3 billion

Fidelity Real Estate Investment Fund

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, which has earned three stars from

Morningstar

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. The fund has returned 74% during the past year, better than 93% of its peers. It has gained 11% annually during the past decade, outperforming 70% of rivals.

Welcome to

TheStreet's

Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks and views on the market in a five-question format.

Are you a real estate bull or bear?

Buller:

I'm a bull in that I expect U.S. REITs to generate a total return, which is in line with their historical average of high single digits per annum. This assumption is predicated on continued improvement of the real estate capital and credit markets and accretive external growth opportunities. Internal growth from occupancy and rental rate gains will be subdued, as real estate is a lagging cyclical sector in a recovery. External growth opportunities for REITs should manifest itself through the acquisition of buildings from "forced" sellers including commercial mortgage-backed securities (CMBS) or commercial bank loan books.

Which do you prefer: REITs or private real estate?

Buller:

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REITs have proven to have the best access to all forms of capital -- debt, equity and preferred -- among all owners of commercial real estate. With this preferred access to capital, REITs should have a competitive advantage in purchasing assets from many of the "forced" sellers that are expected to emerge, whether CMBS, banks or levered equity holders. This should provide REITs with external growth opportunities during a period when they need to offset the negative internal growth from their core portfolios.

Which area of the U.S. REIT market do you find most compelling?

Buller:

I am finding tremendous value in a theme that encompasses almost all sectors. I've begun to weight more heavily those companies that prudently raised capital to pay down debt and lengthen their maturity schedule, and have thus put themselves in a better position to take advantage of external growth opportunities that could present themselves in the near term. These companies have markedly improved their balance sheets with access to cash and lines of credit as a percentage of assets at all-time highs. These companies with superior management teams who have demonstrated the ability to deploy capital effectively can be found in all areas of the REIT market.

Isn't the threat of inflation and higher interest rates a negative for real estate investing?

Buller:

You have to be careful when making that statement. Rising interest rates will increase the cost of borrowing; that much is certain. However, rising interest rates are often associated with an improving economy, which means that the REITs fundamentals are also improving. This can result in more hiring, which increases office demand, increased consumer spending which can result in the need for more retail space, or higher demand for exports which could increase the need for industrial space. All of this can mitigate the rise in rates.

When it comes to inflation, commercial real estate can benefit as the underlying properties also increase in price. This also results in stronger debt as the value of the collateral the REITs loans are written against improves.

What approach do you take when choosing investments?

Buller:

I feel there are three drivers for the real estate markets - fundamentals, technicals and valuation. We feel that technicals are short-term influencers and that the long-term drivers are fundamentals and valuations.

My analysts and I really dig into quality of a company's properties, understanding the supply demand dynamics for the various types of commercial real estate in those markets, focusing on the strength of the balance sheet, which has been critical recently, looking at future earnings growth and also the quality of company management. Ultimately, real estate is a capital allocation business so being confident that management will allocate capital effectively and that it will benefit shareholders is crucial.

For valuations, there are a number of metrics to consider. The two I focus on the most on are price to net-asset-value, or the private market value of the underlying real estate, and price to funds from operation. Adjusted funds from operation takes into account recurring capital expenditures. We also keep well aware of dividend yields, as this is a big driver for many investors getting into the asset class. With the top-down, I'm taking into account our views on the economic environment, state of the credit markets, and determining what sector exposures and other exposures I want in the portfolio.

--

Reported by Gregg Greenberg in New York

.

Before joining TheStreet.com, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.