NEW YORK (TheStreet) -- Commercial real estate has turned into a hot asset class and many fear that the market could be forming a bubble. The word "bubble" has broader implications than you may think.
As I recently wrote, the less speculative investments have a margin of safety; the larger the bubble, the greater the opportunity for profit. I see no indication that real estate bubbles (or speculative bets) are forming and the evidence is clear that REITs are outperforming all other sectors and most are undervalued today, when you compare historical relationships with investment-grade and high-yield bonds.
It is also clear that cap rates have compressed considerably. The income valuation metric (net income divided by purchase price) that we call cap rates is nothing more than earnings multiples (or P/FFO) in reverse (P/FFO is the standard earnings valuation metric for REIT investors and analysts).
Maybe instead of forming a "bubble," commercial real estate is simply becoming more aligned with the other fundamental asset classes (equity, fixed income and cash), making the case that real estate is no longer an alternative, but a core wealth creator.
Also see: The Coolest Army Jobs for Civilians This Memorial Day >>
On Thursday, I spoke with Donald Trump. He provided me with some insight into his vast experience in creating huge real estate wealth (
recently listed Trump's net worth at $3.2 billion and No. 139 on
U.S. list of billionaires). It's clear that cap rates across all real estate sectors continue to compress as investors' search for yield in today's low-rate environment. Conversely, investors should consider the supply-and-demand fundamentals and how they impact cap rates.
Trump explains: "Today there are numerous sectors in the real estate world. It's important to pick the right sectors. For example, Miami is booming. Not because the U.S. is booming, but because South America is booming."
Last year, Trump acquired the Doral Resort & Spa in Miami out of bankruptcy for $150 million. The 800-acre resort complex includes four golf courses, 700 hotel rooms; more than 86,000 square feet of meeting space, featuring a 25,000-square foot ballroom, a 50,000-square foot spa, six food and beverage outlets, and a clubhouse. Trump is under way with a $200 million renovation strategy that is intended to restore the iconic property to its former prestige.
Trump is known for picking up deals at the bottom and in the case of his Miami bet, the newly branded Trump Miami Doral Resort is likely to be a winner. So how does the average Joe turn dollars like Trump? Maybe it's in Trump's hometown.
"Manhattan is a winner and is doing very well. The fundamentals are improving and tourism is up," Trump says.
I agree; there are some good value opportunities with
. Vornado has a total capitalization of around $29.2 billion, with shares trading at $83.92. The investment grade rated (BBB+) REIT has been trying to simplify its platform and that should drive values higher. Meanwhile, investors can clip off 3.5% dividends. Alternatively, SL Green has a total capitalization of $16.3 billion and most of the value is derived from capital appreciation. SL Green has a more modest dividend yield of 1.45% (shares closed Thursday at $91.18).
Trump says that the market "is different today and that interest rates are low and banks have to start lending money. Slowly but surely, the market is recovering. A lot of people have locked in rates and are in a very strong cash position."
I think Trump is spot on! Cash is king and as soon as interest rates begin to rise, we will see more opportunity to invest in REITs. I can't argue the fact that share prices have ramped up, but I think what is different today is that most REIT management teams are better prepared.
"Rates went up quickly after Lehman and people weren't expecting it then," Trump says.
Uncle Ben is hitting investors with head fakes this time and since REITs are likely to see strong growth in earnings (or funds from operations) going forward, operating fundamentals (rents and occupancy) should improve. For that reason, it's important to project your investment strategies on forward FFO growth.
We all know that diversification plays a huge part in portfolio strategy; that's why Trump likes Asia.
"Many places outside of the U.S. are booming, such as China and South Korea."
One of our favorite Regional Mall REITs is
. Earlier this week I interviewed the company's CEO, Bobby Taubman, at ReCon Las Vegas. (You can check out the
). Taubman has three projects under way in Asia and this would be a great way for investors to gain exposure to a high-quality, blue-chip REIT with assets there. Taubman has a total capitalization of around $10.7 billion and shares are trading at $84.87 (with a 2.36% dividend yield).
Whether we call it a bubble or a bear market, I want to be like Trump. Keep my gun powder dry and get ready to buy some bargains. I am waiting patiently on the sidelines so I can seize the next "Doral" -- that means "buying a wonderful business at a marvelous price." That's the name of the game and as we all know, the primary cause of failure is over paying. Be prudent, be patient, and be prosperous. That's the mark of an intelligent REIT investor.
At the time of publication the author had no position in any of the stocks mentioned.
This article was written by an independent contributor, separate from TheStreet's regular news coverage.