Q&A: MARTIN COHEN & ROBERT H. STEERS "REITS ARE AS CHEAP AS THEY’VE BEEN SINCE 1990"

When Martin Cohen and Robert H. Steers launched the nation’s first investment management firm focused exclusively on real estate securities 12 years ago, the tea leaves went from right to wrong. Fast.

“We kicked off just after the tax reform bill of 1986 basically eliminated all the write-offs for real estate,” says Mr. Steers, chairman of Cohen & Steers Capital Management Inc.

“We believed — correctly — that a lot of real estate would be moving from the private to the public sector, and that there was a lot of opportunity there,” adds Mr. Cohen, president of the firm. “Of course, 12 months later the timing looked pretty bad when the market crashed.”

No matter. The duo, who had been fund managers together at two other firms, used the debacle to pick up real estate stocks on the cheap and made a killing — and a name for themselves. Cohen & Steers is now the nation’s largest real estate investment management firm, with $5.2 billion under management. Its mutual funds include the flagship $2.9 billion Cohen & Steers Realty Shares — a no-load open-end mutual fund — and two closed-end funds: Cohen & Steers Realty Income Fund and Cohen & Steers Total Return Realty Fund. In 1997, the firm hatched two more open-end funds: Cohen & Steers Equity Income Fund and the more aggressive Cohen and Steers Special Equity Fund.

Since 1996, when Realty Shares beat the S&P 500 stock index with a 38.5% return — the firm has been struggling as prices of real estate investment trusts — public companies investing in portfolios of real estate — continue to stumble against the overall market. While the S&P is up nicely this year, Cohen & Steers Realty has headed south, even farther than the REIT market in general, and cash is leaking to the tune of $350 million so far this year.

But once again, Mr. Cohen and Mr. Steers see opportunity in adversity. “There is tremendous good value out there,” says Mr. Cohen. “Real estate stocks are as cheap as they’ve been since 1990.”

Q How much should an investor with a modest risk threshold allocate to real estate securities?

C We don’t recommend a particular number, but most allocators recommend between 5% and 20% for an average investor. For a moderate-risk portfolio, I think you’re closer to 20%.

Q How long do you like to hold on to investments?

C We like to stay in a stock for several years.

S Because the real estate cycle is a long-term thing. When a decline or a recovery takes place, it takes several years to unfold. Real estate doesn’t go hot and cold like other sectors, like high tech.

Q Speaking of sectors, which real estate sectors do you like most right now?

C Office looks the most stable, even though it’s been hot for a while. Because the office market was the last to recover, there’s still more upside.

We also like industrial: It’s a high-yield sector with a decent supply-demand situation. And there’s still lots of private ownership — one favorable trend is that corporations still own a lot of real estate they want to get off their balance sheets.

S We also like some retail stocks, particularly regional mall consolidators, such as General Growth Properties.

Q What stocks or sectors are you getting out of?

C We’re moving away from development-oriented sectors, because it’s getting late into the cycle. There’s more money going into development, it’s easier to get debt, so the picture becomes more and more risky. We’re also lukewarm on apartments — basically because of overbuilding in so many markets. They’re significantly underweighted in our portfolio.

Q What’s an example of a company you’ve sold out of?

C Catellus Development Corp. It’s a great company, but it’s a developer.

Q Where exactly are we in the real estate cycle? Wall Street seems to think we’re a lot closer to bust than boom.

B I’d say we’re in the mature phase — occupancies have recovered, rents are rising, property values are rising. Those three things lead to development — and risk. It’s the stage that it’s hardest to make money in.

Q Are you expecting to make money any time soon?

C We’re forecasting from this point forward low- to mid-teen returns: half from income and half from capital appreciation.

Q So, in spite of the scary numbers so far this year, is now a good time to buy REITs?

C Absolutely. Whatever negatives there are have been factored into the stock price. Or more than factored into the stock price.

Q Where’s the upside? As you said, occupancies have recovered, and rents have already been jacked up considerably.

C We’re actually still in the rollover phase. Every year we get more rental income. You take increasing rental rates, acquisitions, and add a little leverage, and you get to mid-teen returns.

Q What’s the current weighting in your portfolio?

C Broadly speaking: 12% in apartments, 6% in health care, 20% in office, 18% in office-industrial, 12% in malls, 8% in strip centers and 7% in hotels. The rest is in diversified companies.

Q How is that different from the weighting a year ago?

C Basically, it’s the same. The real change is we’ve been reducing the number of companies in our portfolio. We’re down to about 40 names from the high 50s.

Q Why?

C Let’s say from 1991 to last year, the rising tide lifted all ships. The way to generate returns was to play the sector rotation game. It didn’t matter so much which companies you owned.

S But the tide won’t lift all boats over the next five years. Sector rotation isn’t as important, and stock selection is rising in importance.

Q Then how about some stock picks.

C (Cleveland-based shopping center owner) Developers Diversified Realty Corp. It’s a real powerhouse that’s been tossed on the rubbish heap with everything else.

S We’re buying Arden (Realty Inc., an office REIT in Beverly Hills, Calif.) We think it’s pretty undervalued.

Q What else is undervalued?

S Actually, we think Starwood Lodging Trust is a good buy. The stock price has really languished since it bought ITT late last year.

C These companies are trading at 9 to 11 times earnings with 6% to 8% dividends. Where else can you find that today? The tide won’t lift all boats over the next five years. Sector rotation isn’t as important, and stock selection is rising in importance

Vite

Martin Cohen, 49, president, and Robert H. Steers, 45, chairman, of Cohen & Steers Capital Management Inc., New York.

Cohen & Steers Realty Shares (assets $2.9 billion) returns: year to date,-6.26%; 1-year, 12.22%; 3-year, 20.58%; 5-year, 14.84%

NAREIT All REIT Index: year to date, -4.56; 1-year, 12.20%; 3-year, 19.83%; 5-year, 14.12%

NAREIT Equity REIT Index: year to date, -4.38%; 1-year, 14.07%;3-year, 19.89%; 5-year, 14.10%

Standard & Poor’s 500 stock index: year-to-date 13.11%; 1-year 30.67%; 3-year, 29.49%: 5-year, 22.15%

Returns through May 31; annualized for periods over one year

Sources: Morningstar Inc., National Association of Real Estate Investment Trusts