Photo by Robert Houser Jay Leupp of Alesco Global Advisors

Analyst turned portfolio manager Jay Leupp tops 2006 Stock Challenge

By Lynn Novelli

Value, market trends, fundamentals. When it comes to picking stocks, everyone has a favorite strategy. For Jay Leupp, winner of the 2006 Portfolio Stock Challenge, his preferred approach for the challenge is to identify the sector leaders and then stay the course. “I made the top picks in the sectors that I believed would show the strongest real estate fundamentals, and then let the picks do the work,” he says. “Despite various temptations during the year to make changes, I stuck with the original picks for the duration.”

		With Returns Like These, Everyone is a Winner In a horse race, it would have been a photo finish between the first and second runners-up in the 2006 Portfolio Stock Challenge.

Leupp, managing principal for Alesco Global Advisors, LLC, created the winning portfolio with Archstone-Smith (NYSE: ASN), CBL & Associates Properties, Inc. (NYSE: CBL), Equity Office Properties Trust, Host Hotels & Resorts (NYSE: HST) and Public Storage, Inc. (NYSE: PSA).

By the end of 2006, Leupp’s portfolio had surged to a total return of 40.8 percent, far ahead of second place finisher Peter Slatin of the Slatin Report by 5 percentage points. In fact, Leupp also beat the performance of the FTSE NAREIT All REIT Index, the primary U.S. REIT benchmark.

Leupp has entered the Stock Challenge in the past, but this was his first time in the winner’s circle. “It was a very satisfactory win with a large margin” he says. He will also have the honor as the final winner of the Stock Challenge, since this was Portfolio’s last year running the competition.

2006 Real Estate Portfolio Stock Challenge Final 2006 Returns
Jay Leupp Alesco Global Advisors	Peter Slatin The Slatin Report	Anatole Pevnev REITcafe.com	Stephanie Krewson BB&T Capital Market	Art Havener A.G. Edwards & Sons	Ralph Block “Essential REIT” newsletter
Equity Office Properties EOP Archstone-Smith ASN Public Storage, Inc PSA Host Hotels & Resorts HST CBL & Associates Properties CBL	SL Green Realty Corp. SLG Mid-America Apartment Communities, Inc. MAA Host Hotels & Resorts HST Extra Space Storage EXR American Campus Communities, Inc. ACC	Kimco Realty Corporation KIM Corporate Office Properties Trust OFC ProLogis PLD Post Properties PPS FelCor Lodging Trust, Inc. FCH	Archstone-Smith ASN Federal Realty Investment Trust FRT ProLogis PLD LaSalle Hotel Properties LHO Crescent Real Estate Equities CEI	Home Properties HME Eagle Hospitality Properties EHP Alexandria Real Estate Equities ARE EastGroup Properties EGP Equity Lifestyle Properties ELS	AvalonBay Communities AVB Ventas, Inc. VTR Federal Realty Investment Trust FRT Sunstone Hotel Investors SHO AMB Property Corporation AMB

Participants in the competition select five companies from the FTSE NAREIT All REIT Index. The objective was to create a portfolio of five individual real estate stocks that they anticipate will be top performers over the course of the year. Participants can make changes throughout the year as they see fit.

In addition, Portfolio asked the participants to predict the year-end value of the FTSE NAREIT U.S. Real Estate Index. However, no one came close to estimating the performance of the index this year. Stephanie Krewson, senior vice president of equity markets at BB&T Capital Markets, was the closest with a forecast of 15.9 percent, which wasn’t even half of the actual 35.06 percent.

In addition to Leupp, Slatin and Krewson, this year’s contestants included Anatole Pevnev, editor of REITcafe.com; Art Havener of A.G. Edwards & Sons; and Ralph Block, editor of The Essential REIT newsletter and winner of the 2005 Stock Challenge.

Picking the Winners

Leupp started by identifying the five sectors that he believed would be strongest in 2006. “Once I narrowed down the sectors to those that were the most promising, I picked the individual stocks based on valuation and growth,” Leupp says. His secret weapon, by his own admission: 12 years experience as a real estate equity analyst with RBC Capital Markets and Robertson Stephens gave him intimate knowledge of the movers and shakers in each sector. He has known all of the CEOs of the companies in his portfolio for at least 10 years.

Selecting Equity Office turned out to be a pivotal decision, although not for the reasons that Leupp anticipated a year ago. “I took a value approach with Equity Office, believing that its stock was trading at a significant discount to the value of its assets,” Leupp says, recalling the situation in December 2005 when he made his selection. As it turned out, others agreed there was untapped value in Equity Office.

Ultimately, his strongest performing value pick experienced a tremendous leap in share value when Equity Office first announced in late 2006 its acquisition by private equity company Blackstone Real Estate Partners, an affiliate of The Blackstone Group, for an initial bid of $36 billion. Blackstone ultimately bid $39 billion for Equity Office for $55.50 per share.

Beyond helping to position him as the Stock Challenge winner, Leupp considers the Blackstone acquisition and privatization of Equity Office as a yardstick for the health of the office sector going forward. “Equity Office’s CEO Richard Kincaid and Chairman Sam Zell made a wise decision for stockholders in accepting Blackstone’s offer,” he says. “Not only did the Blackstone deal make Equity Office one of the top performers, it also is an indicator of the demand for prime commercial real estate and the strength of the office sector.”

Public Storage turned in the second-strongest performance in Leupp’s winning portfolio, closing the year with a hefty 47.4 percent return.

Leupp cites rising occupancy rates and rents and CEO Ronald Havner’s stringent expense management and ability to acquire the competition as major contributors to the company’s strong performance.

Perennial performer Archstone-Smith continued its winning ways in the apartment sector, posting a 44 percent return for the year. Leupp picked this REIT with confidence, based on the company’s track record and the strength of its management team.

“It’s hard to go wrong with Archstone-Smith,” he says. “Multifamily REITs are enjoying a surge due to the shift in the housing market, and Archstone is simply the best in class.”

Leupp says his lodging sector pick, Host Hotels, performed as expected, with a 33.9 percent return for the year. “Our thesis was to be bullish on the high end of resort hotels, and Host Hotels is the largest owner of those types of assets,” he says. “That thesis worked out pretty well for us.”

Among all his picks, Leupp was surprised by the performance of mall REIT CBL & Associates. The company earned a respectable, but not outstanding, 14.8 percent a much lower return than he anticipated for this usually strong player, Leupp admits.

A Look Ahead

Leupp is enthusiastic about the REIT market in 2007. “We are bullish in our outlook,” he says. “We anticipate 15 percent to 20 percent returns across the board in the domestic REIT sector.”

Imitating the pattern set in 2006, the retail flow of funds will continue to drive share price performance in 2007, he says. “The market is awash in liquidity, and I do not foresee anyabatement.”

Leupp says he expects the abundance of private equity, coupled with strategic demand, to fuel merger and acquisition activity throughout 2007. He foresees a tug of war between large-cap REITs and large, well-capitalized equity funds over some of the most desirable portfolios, with office, health care and mall REITs dominating. “Things will get interesting,” he says. “We are likely to see unpredictable teamings among unlikely partners.”

Residential mortgage REITs, which returned an average of 17.45 percent in 2006, will experience “significant acceleration in 2007 as investors pick among mid-grade and sub-prime mortgage originators,” he says. “The driving force behind this activity will be the dichotomy in credit quality between companies. However, even REITs at the lower end still have attractive portfolios.”

In anticipation of this renewed activity in the sector, Leupp predicts that residential mortgage REITs will be among the top performers in 2007. He also selects high barriers-to-entry apartment and office REITs, as well as high-end malls, lodging and health care and residential REITs as the sectors that will have the highest returns this year.

As for investors seeking growth opportunities, 2007 may be the year to look to the international market, according to Leupp. As more countries adopt REIT legislation, investment opportunities worldwide are exploding. “Global returns could be higher than domestic by as much as 300 basis points,” he says.

In 2006, Great Britain approved REIT legislation, and this year we are seeing the first U.K. companies electing REIT status. Not far behind, Leupp says, will be Germany, Italy and countries on the Asian-Pacific Rim. “Within one to three years, Latin America will be the next frontier for REITs, specifically Brazil, Argentina and Chile,” he says.

On the heels of a stellar year, both domestic and international REIT markets still have excellent upside potential in many sectors, Leupp says. “There will be a high degree of volatility,” he says, “but I can comfortably predict that REIT share prices at the close of 2007 will be higher than they were on Dec. 31, 2006.” He predicts more moderate returns across the board.

“I am expecting total returns of 9 percent to 12 percent with dividend growth exceeding inflation and earnings growth of 6 percent to 8 percent,” he says. “Returns will be respectable, but there will be a large degree of volatility during the year.”

Leupp stands by his 2006 investment strategy of selecting REITs with a solid history of leadership in their sector. The proof is in the returns, he says. “It was nice to see that the consistency thesis paid off.”