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Palm Beach Money: Investors need to know their REITs


The Diversified World of REITs

Around for more than a half century, real estate investment trusts have gone from relatively unknown investments to an estimated $389 billion market. The bulk of assets are invested in equity REITs, but the investments range from mobile homes to timber, lodging and resorts to malls and shopping centers, storage facilities to office and apartment buildings, and just plain mortgages. According to the National Association of Real Estate Investment Trusts, the REITs with the most assets include:

  • Regional malls, 14.6%
  • Apartments, 13.5%
  • Office buildings, 11.3%
  • Health care, 10.9%
  • Shopping centers, 8.2%
  • Mortgage REITS, 7.8%
  • As with any alternative sector-specific investment, do plenty of homework before investing. While Lipper, Morningstar, the Motley Fool, NAREIT and others offer educational and/or performance information, consult a financial professional before investing.

    One of the bright spots in the investment landscape the past couple of years has been real estate investment trusts. Created more than 50 years ago with the intended purpose of allowing the little guy and gal to partake in the commercial real estate game, these income-producing investments have had their share of good and bad times.

    Congress created REITs with the Real Estate Investment Act of 1960. Since then, the portfolios of commercial properties have experienced a number of legislative changes along with investor interests and performance scores that have waxed and waned.

    Think back 30 and 40 years to when REITs didn't have the best reputation -- nor were many available. But just as the real estate markets have changed, the number of REITs -- along with investor interest in them -- has grown.

    "REITs now are currently in excess of about $389 billion in terms of total market capitalization," said Keith Dubauskas, vice president and senior portfolio manager at Harris Private Bank in West Palm Beach. "That's pretty strong growth. I believe it's greater than a 14 percent trend growth rate from 1960 to the beginning of 2009."

    REITs and performance

    Over the past few years, this investment choice has shown some real performance muster.

    For instance, looking first at mutual funds, Lipper reports that through June 30, the average total return on the 232 real estate funds in its data bank was up 9.9 percent this year. A longer look reveals that over the past 52 weeks, the real estate group was up nearly 33 percent, and for the past two years, up 43.26 percent.

    Then things changed: For the past three years, these funds on average returned 4.65 percent to shareholders; and over the past five years, 2 percent.

    Moving from mutual funds into performance within the equity arena, the S&P 500 outperformed REITs from the early-to-mid-1990s through 2000. From 2000 through the real estate peak in 2007, REITs outperformed the market. Then came two years of under-performance followed by two years of out-performance, in 2009 and 2010.

    Over the long haul, from December 1971 to December 2010, Dubauskas said publicly traded equity REITs returned more than 12.1 percent while the S&P 500 returned 10.1 percent.

    Making money and REITs

    But there's more to REITs than mere performance, whether that performance is gotten via REIT-focused mutual funds, exchange-traded funds, index funds or individual REIT stocks. In addition to deciding which vehicle to invest in, there are other choices to make.

    For instance, REITs come in three different types, and under those types fall three different categories. The three types of REITs available in the marketplace are equity REITs, mortgage REITs and hybrid REITs. The most popular are equity REITs. Within each category, investors may choose among REITs that trade on the major exchanges just as stocks do; those that are not publicly traded; and private offerings.

    Dubauskas said there are more than 1,100 REITs around today but only 153 are publicly traded. "We at Harris stick strictly to publicly traded REITs because they offer much more transparency, and better disclosure and reporting." Within this world of real estate investments, you'll find two categories of REITs: equity and mortgage REITs.

    Equity REITs represent more than 90 percent of the market. They generate income from rents collected from apartment buildings and other commercial properties.

    "Mortgage REITs basically invest in the underlying loans of commercial properties," Dubauskas said.

    Regardless which category of REIT, by law these products must distribute at least 90 percent of their income to investors annually. The kind of yield that translates to depends upon a number of things, such as the type of REIT (currently there are about 14 types); market conditions; and how well -- or poorly -- a REIT is managed.

    Don Cassidy, president of the Retirement Investing Institute, sees the benefits of REIT investing but also has a few concerns.

    "Most of the creditworthy REITs have refinanced because rates have been cheap, and that's a good thing," he said. "But there are three types of REITs that I don't like: mortgage paper REITs, which play the same leverage game that got the banks in deep trouble; commercial space REITs because of over-capacity; and retail store REITS because the country is over-stored and consumers will likely be tightening their belts for a number of years to come."

    What type of REIT is he a fan of? "I love the apartment REITs, although they are already well-appreciated. And, I would buy preferred REITs for the yields," Cassidy said.

    And speaking of yields

    The iShares Dow Jones U.S. Real Estate exchange-traded fund (symbol: IYR) had a yield of 3.2 percent as of June 6 and represents a reflection of the equity REIT market. That, however, is nowhere near the 19.3 percent yield on the Armour Residential REIT (ARR). A mortgage REIT took the top position in a June 3 Motley Fool online story, "The 10 Highest-Yielding Mortgage REITs."

    To play in the field of REITs, knowing the lay of the land is important. So is understanding current economic conditions.

    With record numbers of unemployed and under-employed, low interest rates, home loans difficult to qualify for and inflation on the rise, many choose to rent apartments rather than buy homes, which is a good thing for apartment REITs. On the other hand, there are many see-through office buildings and empty malls. Add that together to get a sense of the complexity of the REIT marketplace.

    Michael Dixon, director of planning and wealth management at Carl Domino Inc. in Palm Beach, said he suggests clients invest only a small portion of their assets in REITs. "We would use them as an alternative investment and as such the allocation to them would be small."

    From Dubauskas: "Consulting a professional is going to help you understand REITs and the various yields offered. And perhaps more importantly, whether they are the right investment for you, which may or may not be the case."

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