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Stock Strategist

The Market's Most Overvalued Stocks

There are still expensive stocks in real estate.

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In our previous article on the market's most overvalued stocks, we highlighted large-cap stocks that still appeared expensive, despite our opinion that the overall asset class seemed cheap. For this installment, we chose to focus on real estate. Note that this category does not include homebuilders, but rather is dominated by real estate investment trusts and other financial-services firms that focus on real estate.

Although many companies in this arena appear to be selling at a significant discount to their intrinsic values (16 of the 220 as of this writing,  click here to run this screen), there are still several that trade at a premium. To parse these expensive stocks from the pack, we developed a screen to find real estate firms trading at or below 2 stars with no competitive advantages and average or greater-than-average risk.  The result was seven no-moat, average-risk stocks--all of which are REITs.

Below are snippets taken from each of the Analyst Reports, spelling out the downside risks in each of these firms. As usual, we want to stress that these aren't necessarily bad companies, they are simply overvalued, in our opinion. For a more well-rounded perspective, we highly recommend reading each report in its entirety.

Seven Overvalued Stocks

Post Properties, Inc. (PPS)
Industry: REITs
Price to Fair Value Estimate: 139%
From the  Analyst Report: "The firm's efforts to upgrade and diversify are yet to boost profitability; Post's net operating income margin has remained around 55%, despite management citing studies that show its rents are 10%-20% higher per square foot than its apartment competitors. The firm has recently struggled to raise rental rates in its communities, and this difficulty coupled with rising expenses has kept margins low. Poor margins have, in turn, translated into low returns on real estate assets averaging 7% annually the last few years. Post has struggled to return more than our 9% estimate of its cost of capital."

Home Properties, Inc. (HME)
Industry: REITs
Price to Fair Value Estimate: 128%
From the  Analyst Report: "[Recent] purchases are also taking a toll on Home Properties' balance sheet. Debt is 64% of gross real estate assets, up from an already high 60% in 2005. And the firm has to borrow, because it isn't generating enough funds from operations to cover its dividend after redevelopment expenses are deducted. Over the past three years, the firm has averaged more than $100 million in capital expenditures on existing properties--about $2,300 per unit in 2006--and never generated more than $147 million in funds from operations. The capital expenditures have left the firm ill-equipped to cover its roughly $127 million annual dividend payment."

Tanger Factory Outlet Centers (SKT)
Industry: REITs
Price to Fair Value Estimate: 124%
From the  Analyst Report: "Tanger runs fairly lean, so it doesn't typically have a great deal of cash on its balance sheet. While the shopping center REIT retains some of its free cash flow after paying the dividend, it may have a tough time raising the funds necessary to build out its development pipeline if the capital markets turn wary of real estate-related companies. Tanger's lean approach may also limit its ability to take advantage of opportunistic acquisitions."

Mid-America Apartment Communities (MAA)
Industry: REITs
Price to Fair Value Estimate: 119%
From the  Analyst Report: "Mid-America has spent considerable cash to renovate apartments in recent years. Although repairs have allowed the firm to raise rents, profitability has been weak, with the firm's net operating income margins stagnating at around 54% the past few years. Additionally, the firm is having trouble on the expense side with insurance costs rising a whopping 42% in the first quarter of 2007 compared with the prior-year period because of its large footprint in areas vulnerable to hurricanes."

SL Green Realty Corporation (SLG)
Industry: REITs
Price to Fair Value Estimate: 119%
From the  Analyst Report: "Despite being the top landlord in the best office market in the nation, we think SL Green's future rental growth will likely be modest: Just 3% of the company's leases expire during the remainder of this year (and about 7% annually through 2011), which reduces the opportunity to capture high-market rents. Additionally, SL Green's total holdings represent just 6% of Manhattan's estimated 390 million square feet of office space; with such a relatively small stake, we doubt the firm can exercise much clout in the market."

Douglas Emmett, Inc. (DEI)
Industry: REITs
Price to Fair Value Estimate: 115%
From the  Analyst Report: "Growth could be difficult to attain, given Douglas Emmett's lack of a long-term, competitive advantage. Acquiring new properties in prime Los Angeles locations is expensive, and expanding into less desirable neighborhoods could diminish the quality of the firm's portfolio. Expanding outside Southern California has been limited to the Honolulu market, where the firm has so far bought a handful of properties."

United Dominian Realty, Inc. (UDR)
Industry: REITs
Price to Fair Value Estimate: 112%
From the  Analyst Report: "Condo sales have been a bright spot for UDR, but we think the good times are over: The first-time buyers UDR is trying to attract will likely be kept out of the market by rising mortgage rates. Slowing condo sales should boost demand for apartment rentals. Still, the decline in condo sales and the decreased likelihood that UDR can dispose of properties at expensive prices will likely make the company's restructuring process more painful."

Joel Bloomer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.