BlastInvest
Blast Investor Real-time Plus           by Henry Lu

Trade Alert:  CEI - a turnaround office REIT

01/31/2005

Buy Alert

Today I purchased 1000 shares of Crescent Real Estate Equities (Symbol CEI ) at $16.75 price for the Blast Investor Model Portfolio.  The Hot List risk/reward rating for CEI is "extremely favorable".

Crescent Real Estate Equities (CEI) is a real estate investment trust (REIT) with 9% dividend yield. Its primary business is  in office or commercial real estate investment and management in south USA. It also has business in residential real estate development, and resort / hotel real estate operations. Below is the rational for this investment.

CEI - Office Real Estate Gem

REIT -  interest rate hike scare? Bubble talk?

There are many articles in newspaper talking about real estate bubble. Everyone knows that real estate has been pretty hot in past few years, which scares many people who believe what goes up must go down. Recently, many Wall Street analysts believe that interest rate will go much higher from here so that an income vehicle such as REIT will crash just like a typical long bond. Real estate bubble talk plus interest rate hike scare put CEI into very scary investment choice.

I disagree with such simplified conventional wisdom. Real estate is quite complicated beast. Real estate market is also local and segmented. 

While higher interest rate is probably going to be true in near term, I do not believe that office REIT stocks will go down as rate goes higher. Higher interest rate usually is coupled with improving US economy or higher inflation. Therefore, the REITs will have higher rental rate and lower vacancy rate so that they can pay higher dividend as well.

Furthermore, I continue to favor hard asset over paper asset over next few years. The bull market of real estate, natural resources, oil is not over yet. Most likely, when interest rate goes higher, inflation will go higher as well and US dollar is going to be weaker and weaker. In this kind of global economy environment, real estate is going be great hedge to protect wealth. This is pretty darn good economical environment for a REIT like CEI with huge amount of appreciating hard asset behind its stock.

Office Real Estate - weak market

Commercial real estate market was just lukewarm over past 3 years if not cold.  Since the peak of 1999 - 2000, commercial real estate landlords have seen their rents dropping and vacancy going up as US economy encountered recessions and job losses.

CEI stock price history also reflects this awkward situation as well over past 4-5 years. Since the peak price of $30, CEI stock price has been dropping and hovering around $15 to $20 for  many years.  In fact, it has been trading at lower value than its peers for quite while.

CEI - high yield risky REIT?

One reason for the weak performance of CEI stock is its risky dividend yield. Most of REIT investors are income investors. They want high yield and safe yield. Although CEI yield is high, it is perceived to be risky by traditional measure of FFO coverage on dividend. 

FFO (Funds from Operation) is pretty standard industry measurement to measure profitability of REIT stocks. FFO usually is larger than Net Income for REIT. Because REIT net income does not reflect true profitability of company, FFO is typically considered as better indication of true earning of REIT.  Typically, REIT's dividend is smaller than FFO because REIT company can not afford to pay dividend more than it earns.

CEI had $1.5 per share dividend last year, but its FFO was only around $1.20 per share. Actually, only $1.00 was regular FFO, the rest of FFO was special event one-time FFO. Therefore, CEI pays dividend at 1.5 times of what it earns, that is pretty risky. It implies that CEI may suddenly cut its dividend because it can not afford to pay that high yield.

CEI - NAV $20 per share

Let's forget about book value. What's most important measurement for real estate stock is its Net Asset Value (NAV). The concept of Net Asset Value is very simple, just add up all the current market value of real estate,  minus debt and minus preferred stock value, then divided by total number of common shares. Ultimately, when REIT liquidates its all asset and return cash to investors, this is roughly what investors will get for each share. 

By my own calculation and reported by CEI management as well, CEI current NAV value is around $20 per share. While most REITs trade at or above their NAV values, CEI is trading at about 17% discount to its NAV value.

CEI - a turnaround stock with growth

While CEI NAV discount is great, many of BIRTP subscribers may not be impressed because I was able to find value stocks with 30% or even 50% more discount for you before.  However, CEI is not just a typical value stock, it is turnaround stock with earning growth potential ahead. Below is list of reasons:
  1. FFO is just crude method to measure profitability of a REIT. In many cases such as CEI stock, it can be flawed to believe that FFO is all a company can earn.  FFO usually only reflect what a REIT can earn from rental income, it does not reflect what it can earn over appreciation of  real estate price. Let me just give you a simple example, suppose a rental house is worth $100 market price, as landlord you can earn FFO from rental income $7 per year. However, if the house price is going up 5% every year or $5 per year. This $5 per year appreciation is not reflected in FFO calculation. Although FFO is just $7, the real profit a landlord can make is actually $12 or 12% per year for the rental house.  In CEI case, CEI makes much more profit than its FFO due to its real estate appreciation in commercial real estate and residential real estate development.
  2. Over past 50 years of US history, US inflation was 3% per year, and US real estate appreciation rate was 5% per year in average. Although commercial real estate market was pretty cold over past few years, commercial real estate market can turn into hot market with huge appreciation rate in the future just as residential real estate market did over past few years.
  3. Location of CEI office properties (Dallas, Houston, Las Vegas, etc) have top job growth in USA.
  4. CEI management has turned from defensive into offensive with joint venture strategy to get 15% or more return on equity. CEI simply sells partial real estate ownership to outside institution investors and maintain management for the whole building for a fee. The proceeds of sale can be used to buy more real estate at higher rate of return.  CEI makes 2 kinds of profit in office real estate investment: passive ownership of real estate and management fee. Although joint venture approach does not increase passive ownership part, it does increase management fee significantly. This is the beauty of this joint venture strategy.
  5. CEI NAV is expected to grow to $25 per share in 2007 with this offensive joint venture approach. That is 12% NAV growth per year on top of 9% dividend yield!

Huge Insider Buying

CEI had huge insider buying over past few months. There were no insider selling for past 2 years. The CEI stock is pretty cheap so that it does make sense for insiders not to give away their stocks for free by selling them.

Conclusion

Buy CEI for the long term. Target $25 in 2 - 3 years.  Combining with 9% yield, this is about 20% to 30% investment return per year. Maximum target can be much higher if US economy recovers fast or inflation kicks up fast.


Blast Investor Model Portfolio Update

(as of 01/31/2005)

Model Portfolio - Performance


Portfolio inception date
 12/31/2003
Portfolio inception value
 $89,000
Portfolio 12/31/04 value
 $141,981.00
2004 Portfolio Performance
 59.53%
2004 S&P500 Performance
 8.78%
2005 Portfolio YTD Performance
 -5.42%
2005 SP&500 YTD Performance
 -2.76%


Model Portfolio - Open Positions
Symbol Last Shrs Value Paid Gain
ADGO.OB 1.36 9,000 $12,240.00 0.78 $5,210.00 +74.11%
CEI 16.73 1,000 $16,730.00 16.75 -$30.00 -0.18%
CHK 17.16 1,100 $18,876.00 13.90 $3,576.00 +23.37%
EXX-A 1.75 6,500 $11,375.00 1.638462 $705.00 +6.61%
LIBHA.PK 5.25 1,200 $6,300.00 5.10 $170.00 +2.77%
NRG 35.00 670 $23,450.00 23.05 $7,996.50 +51.75%
NTES 42.29 150 $6,343.50 36.60 $843.50 +15.34%
SOHU 15.83 700 $11,081.00 24.882857 -$6,357.00 -36.45%
USG 31.39 950 $29,820.50 18.425789 $12,296.00 +70.16%
WLL 34.20 600 $20,520.00 22.683333 $6,890.00 +50.55%
$$CASH -22,454 -$22,454.00 - - -
11 symbols Total(USD):
$134,282.00




Model Portfolio Transactions
Date  Type Symbol Shares Price Comm Amount Notes
Jan 31, 2005 Buy CEI 1,000 16.75 10.00 16,760.00
-
Nov 24, 2004 Sell HRB 350 47.35 10.00 16,562.50 - 12.31%
Nov 4, 2004 Sell NTES 100 46.50 10.00 4,640.00 + 27.05%
Oct 19, 2004 Buy EXX-A 1,500 1.60 10.00 2,410.00
-
Oct 6, 2004 Buy EXX-A 5,000 1.65 10.00 8,260.00
-
Oct 6, 2004 Sell NEN 100 80.00 10.00 7,990.00 + 48.15%
Oct 5, 2004 Buy USG 250 18.75 10.00 4,697.50
-
Oct 5, 2004 Sell NTES 100 39.12 10.00 3,902.00 + 6.9%
Sep 30, 2004 Buy USG 700 18.31 10.00 12,827.00
-
Sep 29, 2004 Sell NEN 100 79.65 10.00 7,955.00 + 47.5%
Aug 5, 2004 Buy WLL 250 23.50 10.00 5,885.00
-
Aug 2, 2004 Sell NEN 100 69.95 10.00 6,985.00 + 29.5%
Jun 17, 2004 Sell HCA 250 40.30 10.00 10,065.00 - 4%
Jun 17, 2004 Buy NRG 670 23.05 10.00 15,453.50
-
May 24, 2004 Sell ADGO.OB 13,000 1.55 10.00 20,140.00 + 98.7%
May 10, 2004 Sell HCA 250 39.97 10.00 9,982.50 - 4.8%
May 10, 2004 Buy SOHU 200 15.59 10.00 3,128.00
-
Mar 5, 2004 Buy WLL 350 22.10 10.00 7,745.00
-
Jan 26, 2004 Sell WRP 700 17.40 10.00 12,170.00 - 5%
Dec 31, 2003 Buy CHK 1,100 13.90 10.00 15,300.00
-


Date  Type Symbol Shares Price Comm Amount Notes
Dec 31, 2003 Buy NEN 300 54.00 10.00 16,210.00
-
Dec 31, 2003 Buy HRB 350 54.00 10.00 18,910.00
-
Dec 31, 2003 Buy NTES 350 36.60 10.00 12,820.00
-
Dec 31, 2003 Buy SOHU 500 28.60 10.00 14,310.00
-
Dec 31, 2003 Buy LIBHA.PK 1,200 5.10 10.00 6,130.00
-
Dec 31, 2003 Buy ADGO.OB 22,000 0.78 10.00 17,170.00
-
Dec 31, 2003 Buy HCA 500 42.00 10.00 21,010.00
-
Dec 31, 2003 Buy WRP 700 18.30 10.00 12,820.00
-
Dec 31, 2003 Cash In -
-
-
-
 89,000.00 Inception