By Mark Jewell
AP Personal Finance Writer
BOSTON (AP) -- Real estate investors don't have to own property to make a buck. They can invest in stocks of real estate investment trusts, which own and sometimes operate commercial, industrial and retail properties.
In good times, it's kind of like enjoying the milk, without having to buy the cow. You can pocket the gains when REIT stocks rise, without the burden of a mortgage or property upkeep.
More important, investors in REITs and real estate mutual funds can expect steady dividend payouts -- the trickle-down of operating income generated by REIT properties.
Lately, the appeal of investing in real estate without physically owning the property has been strong. Home sales plummeted over the summer after homebuyer tax incentives expired. Lending standards remain tight, foreclosures high.
Although housing has struggled, real estate funds have gained an average 31 percent during the past 12 months. That's the biggest rise among the 21 domestic mutual fund categories that Morningstar tracks, and twice as much as the second-biggest gainer, funds specializing in industrial stocks.
Real estate funds are riding the robust gains among the stocks they buy. Yet they're short of a full recovery from the housing market collapse -- a bust that also spread to the commercial and industrial real estate markets, where REITs are far bigger players. Over the last three years real estate funds have lost almost 5 percent a year, compared with an average loss of 8 percent for the Standard & Poor's 500 stock index.
Still, investors have taken notice of the stocks' partial turnaround, adding nearly $2.9 billion into domestic and global REIT funds and exchange-traded funds the past 12 months. It's more than just return-chasing. Investors, especially retirees, are nervous about stock volatility, and eager to latch onto anything that might offer steady dividend income.
Yet fund managers acknowledge the biggest gains for REITs are probably behind them. They see lingering risks in a commercial real estate market hampered by high unemployment, which reduces demand for office and industrial space.
And some analysts believe the recent gains have left REITs overpriced.
"They're not stocks you should expect to grow 10 percent a year," says Morningstar fund analyst John Coumarianos. "On the whole, REIT balance sheets are still in poor shape."
What's more, the stock gains have lowered REIT dividend yields, which move in the opposite direction of prices.
Coumarianos notes the dividend yield of the benchmark REIT index has been below 5 percent for seven months, compared with a historic average of around 6 percent. The average is now roughly where it stood before the housing market crashed.
The yield measures the amount of the dividend paid divided by the share price. (For example, if a company's annual dividend is $1.50 and the stock trades at $25, the dividend yield is 6 percent.)
Yields for some of the largest REITs are unusually low: Simon Property Group Inc.'s is 2.5 percent, Vornado Realty Trust is at 3 percent, and Boston Property Inc. is 2.3 percent.
Yet dividends are what REITs are mostly about. To escape corporate taxes, REITs must distribute at least 90 percent of their taxable income to shareholders each year. REIT funds typically hand out quarterly payments, representing the total payout from the fund's holdings. Investors can either take dividends as cash, or reinvest by purchasing more fund shares.
Another reason to be wary: Executives and other insiders at some big REITs have been unloading their company stock recently, possibly reflecting a lack of confidence about prospects for further stock gains. Net insider stock sales in the last 12 months have totaled $68.4 million at Vornado and $54.5 million at Boston Properties, according to data from InsiderScore.
Those executives have seen the value of their stocks rise in part due to recent success issuing bonds to finance property purchases. It's a turnaround from the credit freeze, when REITs accepted steep interest rates to raise cash.
For example, the biggest retail property REIT, Simon Property, managed to complete a 10-year debt offering last month with an interest rate less than half of what it paid for a similar deal in March 2009.
"If the mortgage for your home was cut from 10.75 percent to 4.4 percent, just think how much extra money you'd have," says Kenneth Statz, co-manager of the JPMorgan U.S. Real Estate Fund (SUSIX).
Simon's stock is up about one-third in the past 12 months, contributing to the nearly 36 percent gain Statz' fund has enjoyed. Simon Property is the fund's third-biggest holding.
Brian Jones, co-manager of Neuberger Berman Real Estate (NBRFX), says another factor driving REIT stocks is improving cash flow from their various properties.
But Jones expects high unemployment will linger. So he favors REITs targeting industries that can ride out a tough labor market.
Two examples in his fund's top 10 holdings: Ventas Inc. and Digital Realty Trust Inc. Ventas owns housing complexes for senior citizens and other health care properties, while Digital focuses on data centers and tech-related properties.
Health care is a traditional safe haven in tough times, and demand for data centers remains strong.
At the JPMorgan fund, the top holding is Equity Residential, which focuses on apartment complexes. The stock is up more than 50 percent in the past 12 months. Credit a rental market that's held up while would-be home buyers face tougher lending standards and iffy job prospects.
"We think apartment REITs will do well," Statz says. "There's been no new growth in rental supply, yet demand is growing."
Yet Morningstar's Coumarianos argues REITs face too many risks to sustain their recent stock gains, noting they're trading at a historically high prices, measured against their earnings.
Investors should always seek a margin of safety, and REITS, Coumarianos says, "don't offer much of a margin these days."
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Questions? E-mail investorinsight@ap.org.
Published: Wed, Sep 22, 2010
