Apartment stocks have been the stars among real estate investment trusts for the past year and a half. But new commercial-property types could finally be ready to steal the spotlight.Hotels or office stocks likely will be outperformers over the next year, several portfolio managers say, as hotels take advantage of a lack of supply and office owners benefit from low vacancy and heightened merger activity. No one is projecting that apartment REITs will fall off a cliff. But worries about how much rent growth is left nationally, along with fears about valuations eventually correcting in the sector, could crimp the stocks' growth.
Mueller, who writes a quarterly forecast on real estate market cycles, predicts hotels will see 6% organic earnings growth over the next year. Such growth excludes benefits from acquisitions or cost cutting and instead relies on improving occupancies and rents. The next-best-performing REIT sectors, he says, will be office and industrial, which will see 4% growth, followed by apartments at 3% and retail at 2%. The debate, however, is how much this growth is already priced into hotel stocks. So far this year, hotel REITs are up 17%, according to SNL Financial. "Hotels are still reasonable compared to their relative potential earnings growth," says Mueller. In the lodging space, Mueller particularly likes LaSalle Hotel Properties ( LHO) and Marriott ( MAR). Tash also likes the hotel sector and owns Sunstone Hotel Investors ( SHO) and Host Hotels ( HST), but he maintains that the recovery story is no secret. Investors "all know hotels have great pricing power right now," he says, adding that most of the incremental demand is coming from the business segment, rather than the consumer side. Dean Frankel, a portfolio manager with Urdang Securities Management, say his firm is in favor of the hotel sector because it falls into its investment plan of buying property sectors with short-term leases. Hotels are "a big part of the inflation problem, which we like," he says. Frankel believes that Sunstone is a good value right now at just nine times analysts' estimates for next year's funds from operations, a REIT proxy for earnings. He also is a fan of stocks in the full-service hotel segment, such as Starwood ( HOT). He was particularly impressed with the 13% RevPAR growth that Host Hotels
reported this week at the 27 properties it recently bought from Starwood.
Mueller points to SL Green ( SLG), which is a pure-play on Manhattan office space, as a good bet. New York City rent growth continues to hum along, and office properties have been fetching top dollar in the property sales market. Bank of America analyst Ross Nussbaum recently raised his price targets on New York City office REITs because of the strong fundamentals in the market. "With Midtown office vacancy at just 5.4%, buyers are underwriting 25% market rent growth over the next three years, ahead of market forecasts of 14%," he wrote in a research note. This prospective rent growth could also boost M&A activity in the segment. So far this year, Trizec Properties ( TRZ) and Carr America, two large office owners, both agreed to be taken private. "The sector the private market is focusing most on right now is office. A year ago it was apartments," says Tash, the Cliffwood Partners fund manger. Tash has faith in the fundamentals of the New York City office market, but believes SL Green and fellow Manhattan office owner Vornado Realty Trust ( VNO) are hard to buy right now because of their high multiples. His firm has a small investment in Vornado. Robert Promisel, a principal with Adelante Capital Management, which owns both SL Green and Vornado, admits they are not undiscovered stocks. But at the same time, he says, SL Green is trading below where the company's properties would change hands in the private market. SL Green is currently trading around $114. Even if the stock were to reach $120, SL Green's properties would be valued at less than $600 per square foot, Promisel notes. Similar-quality assets in Manhattan have been trading above that price. Vornado might be just as good of a story as SL Green, and perhaps even better. "Vornado is one of the cheapest stocks in the office space right now for a value-oriented investor," Promisel says. "Its valuation suffers from complexity."
SL Green only owns office properties in New York, where the recovery is in full swing. In comparison, about half of Vornado's enterprise value can be attributed to its office portfolio, which is spread between New York and Washington D.C. Vornado operates like a real estate hedge fund and owns retail and office sites, and even makes speculative investments in companies like Toys R Us and Sears ( SHLD). By Promisel's estimate, SL Green's stock price suggests its office properties are trading at a 4.5% yield, whereas Vornado's office portfolio is trading at 5.25%. Both companies will greatly benefit from the continued ability of landlords to push prices in the Manhattan office market, as premium big-block space becomes hard to find. "You're not going to see it in this quarter's release" from the companies, Frankel says. But six to 12 months out, "New York City lease deals will look great," he says.