A great solution to the housing market blues
Pity the beleaguered American homeowner. In the past five years, he has seen the value of his home drop by an average of 33 percent, according to S&P Case Schiller.
Thankfully, there are other types of real estate that have had more attractive returns in recent years. In fact, REITs, or real estate investment trusts, have been on a tear. REITs, which invest in different types of commercial real estate, were hit hard in 2007 and 2008, but have since rebounded strongly.
For the three years ended June 30, 2012, the FTSE NAREIT Equity REIT index had an eye-popping annualized total return of 32.4 percent, compared with 16.4 percent for the S&P 500.
REITs have also offered an attractive alternative for investors seeking yield. As of June 30, 2012, the average equity REIT had a yield of 3.29 percent, compared with 2.08 percent for the S&P 500 and 1.67 percent for 10-year US Treasuries.
REITs at a Glance
Total Return for the Three Years Ended 6/30/12
Yield as of 6/30/12
All Equity REITs
Source: National Association of Real Estate Investment Trusts (NAREIT). Sectors represented by the respective property index components of the FTSE/NAREIT Equity REIT index.
By law, U.S. REITs are required to pay out most of their taxable income to shareholders in the form of dividends. During late 2008 and 2009, many REITs trimmed payouts to the minimum levels required in order to conserve cash during the recession. However, the gradual economic recovery is helping to stabilize cash flows in most commercial real estate sectors. Moreover, a depressed level of commercial construction activity has constrained new competitive supply in many areas while generally serving to increase occupancy levels in existing facilities.
That said, the strong run of REITs in the past few years is a tough act to follow. The prospects for REITs in the near future depend largely upon the property type.
REITs invest is many different types of commercial properties. These include industrial properties such as warehouses, retail properties such as malls, residential or apartment properties, health care facilities such as hospitals, and hotels. Some REITs diversify in many property types, while others concentrate on one or two types.
Although each type of property has its own dynamics, certain national trends appear to bode well for commercial real estate in general. For one, construction in most segments and locations has been minimal in the wake of the recession, so overcapacity and high vacancy rates are not an issue in most areas. For another, the United States boasts a growing population and improving economy (however tepid), which work to the benefit of lease rates and long-term demand.
Certain segments are better positioned than others. For example, multifamily properties are benefiting from declining home ownership rates, resulting in high demand and rising rents in many areas. And the once overbuilt retail sector, with a dearth of new construction in recent years, stands to benefit from rising occupancy levels and rents if the economy picks up steam. Hotels and health care facilities could also benefit from demographic shifts.
It’s important to keep in mind that, as with residential housing, commercial real estate markets vary considerably from region to region, and even block to block. They also vary significantly depending upon the type of property. And, as noted above, different REITs invest in different types of properties. So before investing in any REIT, you will want to do your homework.