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By Andrew Gogerty | 11-30-2010 12:39 PM

Statz: Cautiously Optimistic on Commercial Real Estate

A dramatic decrease in uncertainty and limited supply growth bode well for commercial real estate firms, says JP Morgan US Real Estate's Ken Statz.

Securities mentioned in this video
SUSIX JPMorgan US Real Estate A

Andrew Gogerty: This is Andrew Gogerty with Morningstar and today we're taking a look at domestic real estate funds. The category has continued its strong returns from 2009 through late November. The category is up over 22% making it one of the best returning categories in all of Morningstar's universe. It is also one of the few equity categories that has seen positive inflows this year.

And to shed some light on the category and some perspective, I'm joined today by Ken Statz, Co-Manager of the JPMorgan U.S. Real Estate Fund. Ken, thanks for joining me today.

Kenneth Statz: Thank you, Andy. Glad to be here.

Gogerty: Why don't we start with what I see as a little bit of a disconnect between commentary that we're seeing not only from JPMorgan, but a lot of your colleagues and the returns this year.

Reading your quarterly commentaries and your peers, I think it's best that they're cautiously optimistic, but I don't think you would really see 22% returns and cautiously optimistic. It seems there's a little bit of disconnect.

So what's really going on in the market right now in terms of fundamentals versus may be investor demand for these securities?

Statz: Well, I think partly part of the disconnect that you might be observing right now is where these stocks have come from. Because clearly when we had the severe recession, when the credit markets shut down and interest rates soared for the kind of debt that these companies used to finance themselves, you had a 75% plunge in values. So, we're working our way back up from that pretty big trough level.

So, any one year, you look at the percentage change and you have to remember this is an area that cash flow was under attack because of the terrible economy and discount rates, the cash flow discounting mechanisms that many investors like us use to set value, when the bond markets shut down and interest rates soared that meant the discount rate went up very sharply. The combination of lower cash flow, higher discount rate meant very depressed valuation for commercial real estate. That's what these stocks are. You're buying everyday commercial real estate.

So, let's see what's happening this year. Cash flow is starting to moderate in its downturn. In fact, in many areas we're starting to see glimmers of hope. We're seeing some increases, that's good. Second, the bond markets become very, very accommodative again to REITs. The rates are low, the duration is long and the supply is plentiful.

So you have cash flow stabilizing, discount rates declining and that means values are going up. So, I think the real disconnect is people that are just looking at cash flow are missing the discount rate change, the nervousness, the uncertainty has declined dramatically and that's been the major change that has caused these stocks to rally so strongly this year.

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