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.
On Thursday, I spoke with Donald Trump. He provided me with some insight into his vast experience in creating huge real estate wealth ( Forbes recently listed Trump's net worth at $3.2 billion and No. 139 on Forbes 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.
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."
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. Follow @swan_investor This article was written by an independent contributor, separate from TheStreet's regular news coverage.