Real Estate Operating Companies have Potential

- Alan Lavine and Gail Liberman

And REITs are required to distribute 95 percent of their income to shareholders.

The average real estate mutual fund, which primarily invests in REITs, has grown at a 13.5 percent annual rate over the past three years.

However, one real estate stock fund manager is turning to Real Estate Operating Companies (REOC) for long-term growth over income. Unlike, REITs, REOCs are not required to distribute 95 percent of their income. So they can pump the retained earnings back into new developments. "There are pockets of opportunities in REOCs," says Michael Winer, manager of the Third Avenue Real Estate Value Fund. "The key is to be very specific and invest in well-capitalized companies whose dividends are well covered and secure. These are companies that have tremendous staying power from strong balance sheets."

Winer focuses on long-term capital appreciation rather than income. He's buying REOCs when he thinks the price represents a significant discount to its true value. His fund owns just 30 stocks. Sixty percent of the stocks are real estate operating companies as opposed to REITs. And 70 percent of the fund's top 10 holdings are real estate operating companies.

"Real estate operating companies are a vehicle for growth," he says. "Real estate is a capital intensive business. Companies that retain cash flow have a significant advantage over REITs, which pay out all their cash to shareholders."

Winer says that as cash comes into the fund, he primarily is accumulating more shares in the following companies due to their long-term growth opportunities:

-Saint Joe. Winer sees the company unlocking hidden value in the millions of acres of land in northwest Florida, which is being developed for residential resorts, single family homes, as well as condominiums and malls, offices and industrial space. The company will create residential properties and resorts on valuable coastal land with $500,000 condominiums along the beach. It also owns valuable land adjacent to the proposed Palm City International Airport. -Forest City Enterprises. A commercial real estate operating company that develops projects in urban areas. It is developing an infill area in New York City and is redeveloping the old Denver airport. Its company has properties in 24 states and is well-diversified in office, retail, residential and hotel properties.

-Tejon Ranch Company. This company owns 270,000 acres of land 60 miles north of Los Angeles in Kerin County, California. Much of the land is adjacent to Interstate 5, the nation's busiest freeway. It is considered the next frontier in California land development.

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Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).