REITs Offer Investors Entree to Real Estate
Investors looking for a convenient, relatively inexpensive way to invest in real estate--and earn high yields to boot--are turning to real estate investment trusts.
Shares of REITs--which own shopping centers, office buildings, apartments or other commercial properties, or make loans to them--are enjoying a mini-comeback so far this year. They earned an average total return (dividends plus stock price gains) of 11.08% in the first quarter, compared to a 5.69% total return for the Standard & Poor’s 500-stock index.
That was a welcome turnaround after 1987, when interest rate hikes and weak real estate prices pushed REITs to an average loss of 10.68%. That was their first negative annual total return since 1978, according to Christopher Lucas, research director for the National Assn. of Real Estate Investment Trusts in Washington.
Although short-term prospects are iffy, because of the threat of a recession and a continuing oversupply of office buildings, well-managed REITs generally pay off nicely as long-term investments and inflation hedges, and they should be parts of a diversified portfolio, analysts say.
“On a three-year basis, if you buy (REITs) you’ll be a winner,” says Robert A. Frank, senior real estate analyst at the brokerage of Alex. Brown & Sons in Baltimore. “Over the next six months, you’ll just do OK.”
“It’s a good way for the little guy to be invested in real estate and collect dividends and not see any large loss in capital,” says L. Howard Nichol, vice president of research at Advest Inc. in Hartford, Conn.
Investing in REITs is as simple as buying stocks in General Motors or IBM. Shares of the nation’s 106 actively traded REITs are bought and sold just like other stocks on major exchanges such as the New York Stock Exchange or the over-the-counter market. Many can be bought for $10 to $20 per share. Those that are actively traded are easier to buy and sell than real estate limited partnerships, which generally do not have active secondary markets.
There are three kinds of REITs. The first and most abundant, equity REITs, own properties and pass along to shareholders the profits from rents and increases in property values. The second type, mortgage REITs, pass along income from construction or mortgage loans. The third type, hybrid REITs, own properties and make loans.
Over the past 10 years, REITs on average have outperformed both stocks and bonds on a total return basis, rebounding from the mid-1970s, when many collapsed due to risky strategies and soured construction loans. Now, with better management and less risk, REITs under favorable conditions can provide the best of both worlds: high yields and rising stock prices.
The higher yields come in part because REITs are not taxed at the corporate level and are required to pay to shareholders 95% of capital gains and 85% of operating income. Many now yield between 9% and 12%, tending to be higher for mortgage REITs than equity REITs.
These high yields help moderate the volatility of REIT stocks. Indeed, their shares tend to fare better than other stocks in bear markets but to underperform them in bull markets.
These days, REIT prospects are getting a lift from fears of higher inflation. They also are benefiting from tax reform, which has curtailed demand for commercial properties by tax-shelter-oriented limited partnerships. That, in turn, has shrunk demand for new construction, increasing the occupancy rates of existing properties.
The biggest danger is the threat of recession. While a modest downturn may not do too much damage, a severe slump could sharply hurt demand for commercial space. Financially strapped tenants also may be unable to pay rents. Vacancy rates for commercial properties already stand uncomfortably high in such markets as Houston and Denver.
Equity REITs are likely to be hurt more in a recession than mortgage REITs, because tenants are more likely to walk away from rents than borrowers from loan obligations, Advest’s Nichol says. Also, in a downturn, investors may be attracted to higher yields on mortgage REITs, boosting their stock prices, he says.
“But in a severe recession, both types are in trouble,” Nichol says.
Thus, analysts say, caution is the watchword. Research REITs carefully in prospectuses or through stock market advisory services such as Standard & Poor’s Stock Reports or Value Line Investment Survey.
Choose those with strong managements and consistent track records of dividend growth over at least five years, Nichol says. They should own well-located properties that are likely to maintain value and rental income in a downturn.
Analyst Frank also advises caution when buying REITs investing in office buildings, which are overbuilt in many markets. Shopping centers may be better, he says, because the aging of the U.S. population will boost consumer spending in the years to come, although short-term prospects are uncertain with a possible recession.
REITs recommended by either Frank or Nichol include: Burnham Pacific Properties (American Stock Exchange), which owns shopping centers in the San Diego area; Santa Anita Cos. (NYSE), which owns the Santa Anita race track and other properties, and Weingarten Realty Investors (NYSE), which owns “one of the strongest shopping center portfolios” in Houston and the Southwest, Frank says.
Also recommended: Federal Realty Investment Trust (NYSE), which buys and renovates older shopping centers primarily in the Philadelphia, Washington and northern Virginia areas; United Dominion Realty Trust (OTC), which owns shopping centers and apartments primarily in Virginia and North Carolina; Health Care REIT (Amex), which owns nursing homes in the Midwest, and Mortgage & Realty Trust (NYSE), a mortgage REIT that could gain from a moderate rise in interest rates because it can raise loan rates faster than an increase in its cost of funds, Nichol says.
