John Waggoner
USA Today
Jun. 8, 2008 12:00 AM
Real-estate mutual funds are faring surprisingly well in the worst real-estate market in decades. One reason: Real-estate funds invest in commercial properties, which march to a different drummer than the residential market. Will the commercial real-estate rally continue? Probably, but it wouldn't hurt to move in slowly.
Real-estate funds invest primarily in real-estate investment trusts, or REITs, which, in turn, invest in apartments, offices, storage facilities and other commercial real estate. Real-estate funds have gained an average 6 percent this year, vs. a 5.3 percent loss for the Standard & Poor's 500 stock index with dividends reinvested.
REITS have high dividend yields, which make them popular in uncertain markets like, say, this one. The average REIT yields 5.17 percent, according to the National Association of Real Estate Investment Trusts, a trade organization. In contrast, 10-year Treasury notes yield 4.04 percent, and the S&P 500 yields just 2.01 percent.
Dividends help cushion your portfolio in market downturns. And REITs, by nature, are dividend machines. REITs must pay out at least 90 percent of their taxable income to investors through dividends.
Inflation hedge
Inflation fears help REITs, too. The consumer price index, the government's main gauge of inflation, has gained 3.9 percent the past 12 months that ended in April. Food and energy prices have soared far more, raising fears of a burst of persistent inflation.
People tend to buy real estate, gold and other tangible assets when the value of paper money declines. "In the long term, physical property has offered a hedge against inflation," says Joe Rodriguez, lead manager of the AIM Global Real Estate Fund.
Finally, REITs are also doing well because Wall Street hit them with a wrecking ball last year. The average REIT fund fell 14.7 percent in 2007, according to Morningstar, the mutual-fund tracker. "The REITs' elastic band got stretched so far in one direction last year that there was nowhere to go but up," says Alec Young, strategist for S&P.
Apartment REITs have fared best this year. As banks have tightened their lending standards, more people have had to rent instead of buying their own home - and that helps apartment REITs. Continually falling home prices also spur rentals: People figure they can buy later at a lower price. And, with foreclosures going up, former homeowners have to rent. Associated Estates Realty Corp. (ticker: AEC ), is one of the top-performing REITs this year. The apartment REIT has soared 46 percent this year, including reinvested dividends. AEC's net rent rose 3.1 percent in the 12 months that ended in March, and 4.1 percent for its Midwest holdings.
Sensitive to economy
The biggest problem with REITs is that they're sensitive - that is, they fare best when the economy is roaring, office buildings are filled, and shopping centers hum.
Unfortunately, the economy is barely meowing at the moment, which is why Rodriguez likes health-care REITs.
S&P REIT analyst Robert McMillan likes high-end shopping-mall REITs, which sound like an economically sensitive sector if there ever was one. He argues that retailers sign long-term leases and tend not to shutter stores lightly.
For most people, a real-estate mutual fund is the best way to invest in real-estate securities. But there's a surprising amount of variety. For example, CGM Realty fund, run by star manager G. Kenneth Heebner, has rocketed to a 325 percent gain the past five years. In large part, that's because Heebner defines real estate broadly, including companies with large land holdings.
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