REITs: solid dividends and gains

September 9, 2002

Real estate investment trusts offer attractive dividend yields and total returns in these dry times for stocks.

 

REITs: solid dividends and gains

Jump to:Choose article section...Some promising individual REITS Mutual funds with REITs are another way to go

Real estate investment trusts offer attractive dividend yields and total returns in these dry times for stocks.

By Dennis Murray
Senior Editor

If you don't already own REITs, short for real estate investment trusts, they merit a closer look. These companies, whose securities trade as stocks on the major exchanges, invest in portfolios of properties and allow you to profit from real estate without the hassles of being a landlord. They pay nice dividends, and like other equities, they offer the potential for capital appreciation. Adding a 20 percent allocation of REITs to a diversified portfolio of stocks and bonds boosted its compounded return by an average of 1.3 percentage points annually over the 10 years through 2001, according to a recent analysis by Chicago-based Ibbotson Associates.

Unlike real estate limited partnerships, which typically require investors to plunk down thousands of dollars, you can buy individual REITs or invest in them through real estate mutual funds for far less. Several REIT funds, for instance, have investment minimums of just $250. Commissions and upfront charges are also generally lower for REITs than for limited partnerships. And REITs allow you the flexibility to sell your stake anytime you want to; with a limited partnership, your money could be tied up for years.

"Despite the large amounts of money that have been flowing into REITs in the past two years, they're still reasonably priced," says Anthony S. Vargo, an investment adviser with Pittsburgh-based Legend Financial Advisors. Best of all, REITs pay strong yields because of their tax structure: They escape corporate tax on all taxable income they distribute to their shareholders if they distribute at least 90 percent of it annually. Most remit 100 percent of taxable income and avoid corporate taxes altogether.

Moreover, when interest rates fall, REIT share prices generally rise, increasing your total return. Year-to-date through early August, for instance, REITs yielded an average of 7.2 percent, and for the 12 months through July they returned 13.4 percent. Both numbers far outpace those of the S&P 500. "It's because REITs don't correlate with stocks that they've been a core component of our clients' portfolios for many years," Vargo explains. "They add an element of diversification."

"To have a meaningful impact on a client's portfolio," Vargo says, "we typically recommend that investors put 10 percent of their total assets into REITs and real estate mutual funds."

You can buy any of almost 200 individual publicly traded REITs or 50-odd mutual funds that invest in them. Either way, you should consider them growth-and-income investments and commit to them for at least five years. That will allow you to ride out the backslides that typically follow higher interest rates and higher construction costs, among other factors.

The three basic types of REITs are equity, mortgage, and hybrid. Equity REITs—the majority—rent and sell the properties they own; mortgage REITs make money by providing loans to contractors; and hybrid REITs do both.

Some promising individual REITS

"Retail is the most attractive REIT sector right now," says Carmine D'Avino, an associate portfolio manager with Pinnacle Associates in New York. "The group has held up well through the economic downturn, and should continue to benefit from steady occupancy rates and positive cash flow."

Specifically, D'Avino likes The Rouse Company, which operates more than 200 properties in the US, including Baltimore's Harborplace and Boston's Faneuil Hall Marketplace. "Rouse also runs a land-development subsidiary that's been reporting strong demand," he says. "It will help contribute to the company's growth even if retail starts to sag." D'Avino believes that Rouse, trading at 31 a share, is presently undervalued.

Another strong retail REIT is Simon Property Group, which has interests in 258 properties in 36 states. It returned almost 32 percent in 2001 and 24 percent so far this year.* Morningstar predicts the shares will appreciate at a slower rate over the next 12 months, because a sluggish economy has limited the ability to raise rents. However, SPG's dividend yield (5.9 percent) should remain robust.

Longer term, those REITs that specialize in apartments—including two of the largest, Equity Residential and Archstone-Smith—should benefit over the next couple of years from an anticipated boost in the number of renters, due to the run-up in prices of single-family homes. And unlike other types of REITs, these would actually benefit from a sharp increase in mortgage rates, because it would also help swell the pool of renters.

On the other hand, REITs that cater to corporate tenants are facing pressure, because downsizing and layoffs have lead to lower occupancy rates. With more office space available, many of these REITs have had difficulty raising rents or negotiating higher rates for new leases.

Some still manage to post impressive numbers, though. Of those that specialize in office properties, Duke Realty is a standout, thanks to its good locations and long term, financially sound tenants. Duke's dividend yield was 7.0 percent recently.

As you would with stocks, thoroughly evaluate any REIT before you buy it. In particular, be wary of a REIT that reports, for several consecutive quarters, a large share of income from the sale of properties rather than from leases or management fees. It may be selling to cover sizable debts or to prop up otherwise unsustainable dividend increases.

Mutual funds with REITs are another way to go

Most individual REITs, by virtue of their interests in multiple properties, have built-in diversification. But you can cast an even wider net by investing in a mutual fund that owns REITs. Over the past few years, these no-load funds have done well, and they're still considered solid bets: American Century Real Estate Fund—Investor Class, Cohen & Steers Realty Shares, Columbia Real Estate Equity Fund, and Fidelity Real Estate Investment Portfolio (see "Don't want individual REITs? Try one of these funds").

Before you jump in, examine the breakdown of a fund's individual REITs. "Look for a broad allocation across industries and property types," says Anthony Vargo. A fund that owns REITs covering apartments, office buildings, shopping centers, nursing homes, and hotels will be more diversified and less volatile than one that focuses on just properties in the hotel and leisure industry, for example.

*All returns are through July 31, unless otherwise noted.

 

Don't want individual REITs?
Try one of these funds

 Total return*
1 year3 years (annualized)5 years (annualized)Phone (800)
American Century Real Estate Fund–Investor Class11.6%13.3%6.0%345-2021
Cohen & Steers  Realty Shares7.512.25.8437-9912
Columbia Real Estate Equity Fund6.611.06.0547-1707
Fidelity Real Estate Investment Portfolio11.314.66.5544-8888
All real estate funds10.511.95.4N.A.

 

Advantages of REITs over limited partnerships:

•Steady stream of dividends

•Lower investment minimums

•Smaller commissions, no management fees

•More liquidity

•Greater diversification

 

For more information on investing in REITs, including a glossary of terms and complete list of mutual funds that invest in real estate, visit the Web site of the National Association of Real Estate Investment Trusts (www.nareit.org ).

 

 



Dennis Murray. REITs: solid dividends and gains.

Medical Economics

2002;17:83.