Interest rate fears have battered around stocks over the past week, and the Bricks and Mortar portfolio has not been immune to the volatility.
Real-estate-related stocks have been particularly hurt by rising interest rates. For homebuilders, the rising rates mean increased borrowing costs for potential buyers. For real estate investment trusts, higher bond yields are viewed as competitive to steady dividends.
Despite what the bears say, I believe higher interest rates are just a short-term hiccup for REIT stocks that own commercial real estate, because most of the quality names in the sector are still trading at
discounts to their private market values. That's why I still believe office owner
is a good bet.
The higher rates do, however, spell more immediate trouble for homebuilder stocks -- a main reason why I continue to have concerns about
Despite some sharp moves in portfolio names, I'm maintaining my current ratings. Of the stocks in the Bricks portfolio, those offering the biggest upside from present levels are Macau casino developer
Here is an update on where my picks stand.
Hilton's stock was the subject of a lot of buzz at the recent NYU Hospitality Investment conference in New York City. Joseph Greff, an analyst with Bear Stearns, said Hilton will be the best performer among hotel and gaming stocks over the next year. Look at the shareholder list for the company and you'll see Hilton is a top holding at both Wesley Capital and GEM Realty Capital, two of the smartest real-estate-focused hedge funds around.
Hilton's recent asset sales have come at very attractive prices. This leaves the company well capitalized for its expansion efforts overseas, where it is pursuing lucrative management contracts in countries like India and China.
The move to become an asset-light company also means Hilton will be using property-sale proceeds to buy back shares in bulk later this year, after it pays down debt.
The consensus at the NYU lodging conference was that hotel fundamentals will remain strong through at least next year, benefiting Hilton's entire portfolio.
The U.S. housing market continues to stink, and Ryland's stock remains expensive. The company trades at the highest price-to-book multiple of any large U.S. homebuilder, with the exception of
Even though Ryland's stock is down 25% since I flagged it in late January, I believe the entire sector, led by Ryland, has another down leg ahead this summer. Housing prices are falling. Mortgage rates are rising. Congress is looking into subprime lending.
If housing gets worse and not better in 2008, then Ryland is still very overpriced. Besides its 21% book value premium, the stock trades at 31 times expected 2007 earnings.
Brookfield Properties (Own)
Brookfield Properties, which owns office buildings in New York City and other major cities in the U.S. and Canada, is down 10% since I
recommended it in late January.
The stock, at around $26, is even more attractive now. My estimates say Brookfield's net asset value, or the private market of the real estate, is worth $34 per share based on market cap rates, or initial rates of return, on office acquisitions.
Several industry experts at the REITWeek conference in New York last week said cap rates in major U.S. cities haven't moved much in recent months despite interest rates creeping up. The reason? A lot of capital is looking for purchases.
However, even if cap rates increase 25 basis points, thus depressing property prices, then Brookfield's NAV is still $31. Either way, Brookfield continues to trade at a 15% to 25% discount to its true value. It also offers a respectable 2.3% dividend yield.
The discount may be partly attributable to worries about Brookfield's residential-development business. But Brookfield's housing business is almost entirely in the Alberta region of Canada, where housing prices rose 30% in April from a year ago because of the booming oil economy. Only a small piece of Brookfield's residential business in the weak U.S. homebuilding market.
The residential business is very profitable for Brookfield, with a whopping 38% gross margin last year. The company mainly buys lots and entitles them for builders, rather than building houses itself.
Penn National (Own)
The decision by West Virginia voters to not approve table games at racetracks in the state was a blow to
. But the company's diverse U.S. racetrack and casino revenue, as well as its very strong profit margins, make it a key holding in the portfolio. At 11 times trailing cash flow, the stock is reasonably priced.
Another attractive characteristic of Penn: The company's capital expenditures for development are set to end in late 2008. This means there will be a huge stream of free cash flow that the company can use for share repurchases, acquisitions or more developments.
I've been saying for months that
no chance of moving higher absent a buyout -- and that thesis has proved true.
Shares of Trump are down 18% since I flagged the stock in late January. Revenue in Atlantic City, where Trump has all of its business, continues to drop from a year ago because of new slots competition in Pennsylvania. Gaming revenue in the city fell 5.5% in May.
Trump's stock has bounced around on reports of buyers interested in the company. But the toughest piece of any deal is the $100 million that any buyer would have to pay Donald Trump to handle his tax bill from the sale. As well, the huge amount of capital expenditures needed to bring Trump's casinos in line with the rest of the competition in Atlantic City means any buyer needs to have very deep pockets.
Home Solutions of America (Flag)
Last week, I reported that
Home Solutions of America's
record $100 million New York construction contract faces questions. Reports from the
Tampa Bay Business Journal
say the $100 million contract in Florida also cannot be fully verified.
Management has remained silent. I don't expect this to change anytime soon, and I continue to think this name is risky. Earnings are likely to disappoint this year, for reasons I detailed in a
Home Solutions' stock is up 23% since I flagged it. However, I expect my call to play out over the next year, as day traders (who I believe populate much of the stock) will exit the name once they realize this company is overpriced given its lack of a sustainable earnings model.
This casino developer continues to be a huge drag for the portfolio, with the stock down 20% since I recommended it. The latest concern is that a temporary visa crackdown in China will hurt profits at the company's first casino, which opened in May. I continue to think the stock offers considerable upside and not much further downside, as I explained
earlier this week.
SPDR Dow Jones Wilshire International Real Estate ETF (Own)
Any way you do the math, global real estate is a great addition to a portfolio. It substantially reduces risk because of a low correlation to U.S. stocks and U.S. real estate. The
SPDR Dow Jones Wilshire International Real Estate
exchange-traded fund is a simple way to own global real estate, while also excluding U.S. properties.
In conclusion, if you give equal weight to my picks, the Bricks and Mortar portfolio is up 1% since its inception in late January. I'm happy with this performance, since during the same time period, the Philadelphia Housing Index is down 7.2%, the
iShares Dow Jones U.S. Real Estate
ETF is down 6.3%, and the
Gaming and Casino fund is down 3.8%.
is up 6.5% since then, but it makes sense for my real-estate focused portfolio to trail the S&P. The Bricks results show how diversified investing across casino, homebuilder, and REIT stocks is better in a volatile period than just investing in an REIT, homebuilder, or casino index by itself.
In keeping with TSC's editorial policy, Yulico doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.