The bloom is off single-family houses, but two other sectors of the market look like winners.


Real estate investments of all kinds have soared. During the five years ending on September 30, the average real estate mutual fund returned 21.9% annually. Now, however, housing sales are slipping, and some analysts say that prices of office buildings and shopping centers may be peaking. But not all real estate stocks are necessarily headed down. Companies that invest in hotels or apartments could still turn in strong results.

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Hotels appear especially strong. Simple supply and demand explains the industry’s health. While demand for hotel rooms is growing about 3% a year, the industry is only building new rooms at a rate of about 1%.


The hotel business typically rises and falls with the overall economy. As the economy grows, more tourists and business people travel, filling hotels and pushing up room rates. Seeing the strong demand, developers normally begin building new units. But this cycle, the industry has been slow to break ground. The reluctance to build can be traced in part to the terrorist attacks of September 11th.


By the end of 2001, travel had ground to a halt, and the economy was slowing. Gradually home building and other industries began to recover, but the hotel business remained stubbornly slow until 2005, when travelers began hitting the road again. Hotel developers are just beginning to pour cement, so, unless the economy tanks, it will take several years before supply catches up with demand.


Portfolio manager Samuel Lieber, of the Alpine International Real Estate Fund, favors resort hotels and high-end facilities in major cities with the greatest shortages of rooms. The upscale projects typically take four or five years to develop. Lieber recommends Diamondrock Hospitality Company, a real estate investment trust (REIT) that owns Marriott hotels in downtown Chicago and Vail, Colorado, a tony ski resort.


Lieber also likes LaSalle Hotel Properties, a REIT that owns hotels operating under a variety of brand names, including Hyatt and Sheraton. The company’s biggest properties include Hilton San Diego Resort, an oceanfront facility, and West Copley Place, a Boston hotel with big conference facilities for business groups.


Like hotels, apartments have been enjoying a burst of new demand during the past year. Much of the strength of the market can be traced to the decline in demand for high-priced single-family houses and condos. “We are seeing a huge demand for apartments in cities like New York, where buying a condo or house now seems expensive,” says a New York developer.


To invest in the apartment revival, consider Archstone-Smith, a REIT that owns more than 82,000 units in New York, Washington, and other cities. Many of the Arch-stone apartment complexes are upscale properties with low vacancy rates.