The Basics: The T. Rowe Price Real Estate Fund has $2.5 billion in assets, with 20 percent in apartments, 18 percent in regional malls, 15 percent in office buildings, 13 percent in small shopping centers anchored by grocery stores, 8 percent in hotels, 5 percent in industrial property, and the rest in diversified property (including self-storage, health-care facilities, and timber) plus cash reserves.
INSTITUTIONAL INVESTOR: Is “real estate” a poison term now? Is this a bad time to be in the space?
LEE: There are a number of different forms of real estate. No doubt it’s been very painful in residential real estate, and that may or may not continue. It has also to a certain extent been painful in commercial real estate, but a lot of what went into this sector were reasonably sound business decisions. It really hasn’t been a political agenda that everybody should own an office building.
II: But don’t the same economic factors hurt both residential and commercial property? If people don’t have jobs, they can’t afford their mortgages. They also are not going to shop as much, and companies don’t need as much office space to house people they’ve laid off.
LEE: Yes, a lot will depend on the economy. But it’s not all bad. Earnings for corporate America have been coming in pretty well this quarter, and they’re still paying the rent. Many of our [office] buildings are secured with long-term [10- to 20-year] leases to creditable corporations. Those lease streams do help you weather some downturns.
II: How about retail?
LEE: The consumer has driven about two-thirds of the economy historically. We would expect recovery is going to entail some form of recovery in the consumer sector. This is a society that does like to spend. Rumors of the demise of the consumer might be overblown. You’re starting to see some recovery in retail, but it’s been hesitant and hasn’t been as certain as we’d like.
II: Once demand picks up, is there a huge backlog to work through? How high did vacancy rates get?
LEE: Vacancy definitely increased, but in many property types it seems to have bottomed. Occupancy was in the 90s [before the recession], with single-digit vacancy rates. Now vacancy is in the teens, depending on the property. The suburban office market is suffering, and some industrial property.
II: Which sectors are doing better in terms of vacancies?
LEE: Apartments and hotels with the shortest leases were hurt first, and they have started to recover fastest.
II: How about new supply?
LEE: The industry as a whole really shut down the construction pipeline. [According to Citigroup, construction starts have dropped 80 percent, on a square-footage basis, from the pre-recession peak.] So even when the demand comes back, when we start creating jobs again, we’ll start to fill up that vacancy, and we can start pushing up [rental] rates.
II: But have some social factors changed permanently that could decrease demand? People working at home, for instance.
LEE: Secular factors have also changed that could increase demand. Enough people were burned in the for-sale housing market, there’s not as much of a frenzy to get into that. And we’ve become much more stringent in underwriting [mortgages]. I think home ownership will come down, and that could bolster the demand for apartments.
II: What other secular changes are happening?
LEE: We’re more of a just-in-time type of society, which could increase demand for high-throughput [distribution and logistics] industrial properties.
II: Now the Fed is starting to worry about deflation. Will buyers or renters hold back to wait for prices to fall?
LEE: Deflation is a concern, but inflation is also a concern. Historically, real estate has been viewed as a strong hedge against inflation. There’s almost always demand for the best properties in the best locations. The Apple Store will pay fine rents to be in the GM Building overlooking Central Park.
II: Location, location, location! But how has all this turmoil affected your fund’s returns?
LEE: Surprisingly not as much as you’d think. The 10-year annualized return, compounded, on this fund is 10.43 percent, compared to a negative-0.82 for the S&P [Standard & Poor’s 500-stock index]. We went through a very challenging 2007-2008. In 2008 it was down 39 percent.
II: Any last advice for investors?
LEE: This is not meant to be the majority of anybody’s portfolio; it’s meant to be part of a diversified strategy and held for the long-term perspective. And at least you’re getting paid [through rents and dividends] while you wait.
