Real Estate Revival Seen by Fund Managers

NEW YORK ( TheStreet) -- Real estate mutual funds have been soaring. During the past year, the funds returned 39%, outpacing the S&P 500 by 25 percentage points, according to Morningstar.

The rally has been driven by an improving outlook for commercial real estate, which includes offices, apartments and warehouses. "Many markets are strengthening, and we should have good demand for real estate for at least the next three or four years," says Marc Halle, manager of Prudential Global Real Estate ( PURAX).

The positive outlook represents a big change from the turmoil of 2008 when financing disappeared and values of many properties collapsed. At the time, some analysts predicted that the commercial real estate industry would not recover for five years or more.

Now the pessimistic forecasts seem to have missed the mark. In recent months, many markets have been reporting improving vacancy rates. At the end of the second quarter, the vacancy rate for offices in central business districts was 14.8%, down from 15% in the first quarter, according to Cushman & Wakefield, a real estate firm. The modest change in vacancies represented an important sign that the cycle was moving up, analysts said. The vacancy rate had bottomed at 9.7% in the fourth quarter of 2007, and then it rose for nine straight quarters.

Halle of Prudential says the downturn is proving to be shorter-lived than the last property recession, which began in the late 1980s. In that cycle, real estate prices fell steadily for more than five years. At the time, many markets were overbuilt, and some office buildings were entirely empty. This time, fewer markets are overbuilt because construction has slowed markedly in recent years. Lenders were unwilling to finance most projects from 2007 through 2009.

Because it takes several years for projects to be completed, it will be some time before new supplies hit the markets, says Halle. Meanwhile, vacancy rates will continue declining as the economy grows modestly.

To profit from the real estate rebound, consider owning hotel shares, says Joe Smith, manager of ING Real Estate Fund ( CLARX), which has returned 10% annually during the past 10 years, outdoing 76% of its competitors. Smith says hotels are among the first properties to turn around when the economy recovers. As soon as bookings increase, hotels raise their room rates. That started in the second quarter. "Hotel revenues tend to increase immediately when there is growth in gross domestic product," Smith says.

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