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David Lee of T. Rowe Price Real Estate Fund tells how he’s outperforming rivals—and the lay by market—and that which property groups he likes now

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After a great run, real position investments have suffered over the past year, with the mean proportion real estate mutual fund down 18%, according to Morningstar. David Lee has managed the $2.5 billion T. Rowe Price Real Estate Fund (TRREX) since it opened in October 1997, so he has seen tough times before. In the two years after the national debt started, shares of absolute estate investing. trusts (REITs) lost almost 20%, even in the same proportion that the Standard & Poor’s 500-stock exponent raced ahead 50%. "Even my family was calling up saying they were going to repudiate me," Lee jokes.

But starting in 2000, real estate shares went on an incredible seven-year run, ignoring the Internet crash and more than doubling, on average. Lee’s resources has gained almost 13% a year over the past 10 years, beating the S&P 500 by more than 8 percentage points annually and performing better than three-quarters of all actual estate funds. Boston-based BusinessWeek correspondent Aaron Pressman spoke with Lee at Morningstar’s (MORN) annual conference in Chicago on June 27.

Real estate was the most profitably place to have being conducive to a while, but that run seems to have ended. What’s hurting real estate investment trusts?

After those seven years, a correction wasn’t surprising. I won’t say it was expected, but it wasn’t unanticipated. So far this year, we’re just surrounding flat, while the overall market is down 8% or other, so we’re outperforming again. I suppose you could call it a Pyrrhic victory.

It’s as simple as the frugality. You’ve five months of work at jobs losses now, and this group correlates closely with piece of work creation. Office buildings require job creation, obviously, and shopping malls need the retailers to grow. So the demand border is down temporarily. We’re not at panic button-type levels. Long term, we’re very bullish on the U.S. economy. That’s been a very kind bet.

We’re exceedingly optimistic about supply. There hasn’t been a haphazard of new commercial actual estate construction this year. Commercial construction starts have fallen off a cliff. So that bodes well for an eventual recovery, although I can’t prophesy exactly when it will start.

Has the credit crunch hurt the sector much? Aren’t real estate companies frequently in need of fresh loans?

The real question is whether these real position companies inclination be able to refinance their debts, and the answer is they’ve been able to so far. The public companies are prudently capitalized. Look at Simon Property Group (SPG). They just did a debt offering, and it was oversubscribed. They got a surpassingly good rate.

Potentially, more difficult times may be ahead because of more leveraged companies—some of the private companies. I dare banks are going to demand more equity before construction those loans.

In general, public REITs aren’t heavily leveraged, certainly compared with their private counterparts. The public markets have done a good job of policing that. Anybody who tried got bring forward in the penalty box; it was so expensive for them to raise fair play that it didn’t make sense. A lot of the companies in our fund receive balance sheets to demand advantage of potential weakness in the market if there are compelled sales.

The consumer is also having a tough time, and I keep interpretation about retail chains closing stores. Won’t that hurt the retail-oriented REITs?

We veritably like the mall companies. There’s good scarcity value in regional malls and not a haphazard of figure going upon the body in the bruise business. Short of going bankrupt, we’re not convinced that wholly these retailers can stop up their way to profitability. They’re going to continue to pay rents to have stores in the highly productive malls.

I thought mall operators charged each store a percentage of sales for rent, so don’t the operators put up with if consumer spending drops?

Regional mall companies have moved absent from percentage [of sales] rents to contractual rents. They be possible to handle these short-term lulls because of the contractual rents.

The Federal Reserve seems to be signaling that one attract rate hike is adhering the horizon. Do REITs get hit if the Fed starts hiking rates?

If the Fed is raising rates because of inflationary fears, real estate has historically been used as an inflation hide. So that could be good for REITs. If the rate hike is because the economy is strong, REITs all own natural assets with physical demand, thus that’s also pretty large.

Among the various subsectors of REITs, that are you looking at for the best values?

We’ve never been in mortgage REITs. We do own residential chamber communities, some of which are starting to benefit from the housing locality: It’s harder to get by payment homes, in like manner there’s a greater propensity to rent. Industrial REITs, with warehouses, are pretty economically sensitive right now.

Your fund doesn’t own any of the so-called specialty REITs, such viewed like trusts that admit nursing homes or computer data centers. Why is that?

We’re heavily concentrated in what I’d call the major food groups. We port’t been in health-care REITs, and right now would exist the bad parturition to do that. We don’t own any of the technology center REITs, either. We’re not into the specialized REITs that are tied to a especial use and a particular industry. I’d much rather walk with prime locations. Some of the specialized trusts could subsist good funds, but it’s just not the way we invest in real estate. I focus forward locating, locating, location.

Does the means look outside the U.S. much?

A apportionment of companies are doing that for us. We’re seeing international expansion by AMB (AMB), ProLogis (PLD), Kimco Realty (KIM) and Simon, for example. That’s how we’re getting international exposure. And this might be the best asset class for international expansion.