Fidelity, Franklin hit as real estate funds lose $13 billion

Fidelity Investments, Franklin Resources Inc and Kensington Investment Group Inc. are the biggest losers in a decline by US real estate funds that wiped out $13 billion in the past three months.

Property funds, the best performers in 2006, slumped 16 per cent since May 14, the most of any category tracked by research firm Morningstar Inc. in Chicago. The $5.9 billion Fidelity Real Estate Investment Portfolio, the largest among the group, fell 19.7 per cent.

The $718 million Franklin Real Estate Securities Fund and the $500 million Kensington Strategic Realty Fund each dropped 20.3 per cent, the most among actively managed property funds with more than $100 million in assets.

House prices will suffer their first annual decline since the 1930s as rising mortgage rates hurt demand, according to the National Association of Realtors in Chicago. Investors pulled $4.5 billion from real estate funds in the past three months after a drop in commercial property shares slashed returns.

"Even though the subprime crisis is mainly hitting residential real estate, commercial is getting pretty hard hit on lower expectations for US growth,'' said Brad Durham, managing director of Emerging Portfolio Fund Research.

Fund redemptions, combined with stock-market declines, reduced assets to $66 billion as of August 8 from a peak of $82 billion three months earlier, according to Emerging Portfolio Fund Research, a fund market-analysis firm in Boston.

Investors placed $3 billion into property funds so far this year, following returns of 31 per cent in 2006, twice that of the Standard & Poor's 500 Index.

The US housing slump is eroding the value of most real estate funds and threatens to slow the economy, which grew 3.4 per cent in the second quarter after expanding 0.6 per cent in the previous three months.

Consumers, whose spending accounts for the biggest part of the economy, are taking less equity out of their homes to buy furnishings, cars and other goods.

Home Depot Inc., the world's largest home-improvement retailer, on August 14 said profit fell 15 per cent and revenue dropped for the first time in four years on less demand for appliances and remodeling.

Jeremy Grantham, who helps oversee $150 billion as chairman of money manager Grantham, Mayo & Van Otterloo in Boston, said declines in real estate investment trusts are a result of the rout in the mortgage market.

Record defaults of subprime loans, given to people with little or no credit history, have deepened the housing slump and decreased demand for REITs, set up for individual investors to own commercial property such as offices, malls and hotels.

"With REITs, the contagion is directly from the housing market,'' he said. "Recently, REITs have been acting atrociously.'' REIT shares have fallen 19 per cent this year, and homebuilder stocks have tumbled 43 per cent.

The best-performing real estate fund is the $1.7 billion CGM Realty Fund, managed by Kenneth Heebner in Boston. The fund declined 6.6 per cent during the past three months, reducing this year's gain to 4.8 per cent. No property fund tracked by Morningstar posted a gain in the past three months.

Heebner is helped by a flexible strategy that allows him to invest in casino companies, commodities and non-US holdings. BHP Billiton, a mineral exploration company, is his second- largest position.

The Melbourne-based company's shares have risen 31 per cent this year. The fund's top pick is New York- based office landlord SL Green Realty Corp., which has declined 22 per cent on the New York Stock Exchange.

Fidelity's real estate fund, managed by Steven Buller in Boston, has fallen 17 per cent this year, trailing 90 per cent of rival funds with a similar strategy. The fund's biggest holding is White Plains, New York-based Starwood Hotels & Resorts Worldwide Inc., whose shares have fallen 14 per cent this year as consolidation in the hotel industry has slowed.

Blackstone Group LP, the New York-based buyout firm, in July said it would buy Hilton Hotels Corp., Starwood's larger rival, for $20 billion.

Simon Property Group Inc., the largest US shopping mall owner, is the fund's No. 2 investment. Its shares have declined 15 per cent this year. The fund hasn't invested in any homebuilders. Buller wasn't available for an interview, Fidelity spokeswoman Sophie Launay said.

"The fund's relative performance has been primarily affected by an underexposure to companies that have been the target of consolidation, M&A or privatization activities,'' Launay said. "The fund has had solid long-term performance.''

Over the past five years, the Fidelity fund has climbed 19 percent, compared with 11 per cent for the S&P 500.

Franklin's real estate fund, managed by Alex Peters and Sam Kerner in San Mateo, California, fell 22 per cent this year, more than all other actively managed real estate funds tracked by Morningstar. The fund's holdings include homebuilders D R Horton Inc. in Fort Worth, Texas, and Miami-based Lennar Corp. D.R. Horton's stock has fallen 41 per cent this year, and Lennar's shares have dropped 43 per cent. Peters was not available to comment, Franklin's spokesman Matthew Walsh said.

Kensington Strategic Realty Fund has declined 17 per cent this year, in part because of companies that provide commercial mortgages such as iStar Financial Inc. Shares of New York-based iStar have fallen 34 per cent this year as investors became concerned that the subprime crisis would spread to corporate borrowers. About 8.5 per cent of the fund is in companies with ties to commercial mortgages, said Paul Gray, co-chief investment officer of Kensington.

"There is a general perception that all things real estate are bad,'' Gray said from his office in Orinda, California. "It is overdone. It's a great entry point for longer-term investors.''