How to buy REITs in a crowded market

Bargains are gone, but thin supply supports prices

June 01, 2012|Rachel Koning Beals

marketwatch.com

CHICAGO (MarketWatch) — Real Estate Investment Trusts have been a shelter in the storm.

REITs make for a near-perfect recovery story. This battered area bounced back from the credit crisis faster than the rest of the financial sector and has provided income-oriented investors with juicy yields. REIT mutual funds, for example, rose 7.5% on average in 2011, beating the Standard & Poor’s 500 Index’s(US:SPX) 2.1% total return.

Indeed, the popularity of this bond and stock hybrid is largely due to those plump yields. The average REIT yielded 4.34% last year, compared to an average 1.87% yield for a 10-year Treasury note, according to the National Association of Real Estate Investment Trusts.

Except REITs’ attributes are no secret. Demand for REITs may have squeezed out much of their value.

Scott Crowe, global portfolio manager at Cohen & Steers, said the run-up, especially in U.S.-focused investments, has dulled some of REITs’ appeal. Still, he expects average earnings growth across REITs in the respectable high-single-digits.

Yet, as a diversifier and inflation hedge, REITs have a place in most portfolios. And if you already have REIT exposure, it’s probably worth keeping.

REITs hold physical properties that generate revenue from rent payments — think shopping malls, hotels, hospitals, offices and timberland. They receive favorable tax treatment for distributing a significant portion of revenue as dividends: a win-win for both the REIT and investors.

“REITs provide another layer of diversification since the assets show lesser correlation to the overall stock market,” said Tom Lydon, president of Global Trends Investments and editor of ETFtrends.com. “REIT ETFs provide investors with a broad, diversified mix, which helps investors to avoid picking out the wrong REIT security,” he added.

Scant supply

Some experts argue that REITs are too closely aligned with stocks under tough market conditions. Investment in REITs plunged almost 50% during the real estate market collapse and financial crisis. And the category’s recent gains are already showing signs of cooling. The Dow Jones All REIT index posted a total return of 10.5% in the first quarter, down from a 15% gain in the fourth-quarter of 2011.

Marc Halle, managing director at Prudential Real Estate Investors, said the fundamental case for REITs is intact.

“Nothing moves up in a straight line,” he said. “Real estate is a simple business of supply and demand and a look through the major markets reveals no significant new supply down the road.”

After all, major commercial projects don’t pop up overnight; construction typically lasts three to five years from groundbreaking. And, as global banks deleverage, only real estate firms able to borrow in capital markets have had the financing to expand. Balance sheets are back in order, favoring the soundest REITs.

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