REITs Whimper After Relatively Strong Year

When the recession began, REITs held up well. Two years ago, the Dow Jones REIT Index rose to over 300. In the next year it slipped modestly, remaining over 250 when many other stocks did much worse. Last September the index fell off the cliff, plunging to under 100 in less than 2 months. It remained oversold until March 2009 and then began its recovery. Since than the Index has doubled from its low to 161. Most attention has been on its gain of 72% from depressed levels 6 months ago (two quarters).

Late last year, risk averse was the motivating force for stock investing causing most securities (especially high yields) to plummet and then continue in the dumps. As the credit crisis receded early this year, risk has come back into vogue and now risk is being rewarded.

Profitable investing in REITs comes from dividends and appreciation. Because of traditionally high yields, dividends have provided most of the gains. With the rise in stock prices, yields have fallen to moderate levels. At some REITs, dividends were cut back to conserve cash. Yields fell to only modest premiums (i.e. risk premium) over the 3.19% yield on the 10-year Treasury bond. Dividend increases going forward will probably be limited in the next few years.

"For rent" signs are becoming more common which will cause vacancy rates on rental properties to rise further. The Dow Jones REIT Index fell 9% from its recent high two weeks ago, after its spectacular rise of 72% in the prior 6 months. That may be an early signal of an overbought market (REIT and major averages) or maybe it's just a temporary blip in a bull market that will keep rising. REITs own property (long term assets) financed by mortgages (long term debt).

But dreary short term considerations are of paramount importance today when investing in REITs. If the economic recovery is slow, it will be painful especially for real estate investments. This is a good time to await developments.

Comments

[Alan Young:]

Most of what you say is true, but you've omitted a couple other major factors making REITs rather odious today. One is that most REITs have mortgages that need to be refinanced soon, but the property values have fallen to where it is no longer adequate collateral for the amount owed. This is a huge problem hanging over the sector.

The second issue is that many REITs are protecting their scant cash resources by paying dividends (which are required for them to maintain their tax advantage) in stock instead of cash. Since the stock issued as dividends simply dilutes the existing shares, this makes the "dividends" completely worthless.

I can't think of any reason to invest in this sector anytime soon.

Oct 04 05:57 AM

[M/M:]

Whether REITS are a good investment depends on your time horizon. In the short run, I agree that the fundamentals of most sectors are weak and will take a long time to recovery. We need sustained improvement in GDP, employment, and global trade. But longer term, as REIT shares pull back this may be a good opportunity to invest. Share prices will turn up long before fundamentals. I'd look for REITS with good dividend yields and good dividend coverage. Health Care reits offer high dividend yields as do some industrial reits.

Oct 04 12:06 PM

[Trane250:]

The anxiety over REIT mortgage refinancing is overblown. The banks will compromise and accommodate wrt the decreased cash flow that REITs will have available to service mortgages. They don't want to be stuck with more foreclosed properties.

Do your homework before you invest, but the opportunity to make big bucks in REIT stocks is out there.

Oct 04 12:25 PM

[mbkelly75:]

It is a really good time if two things are true for you. 1) long-term viewpoint (5+ year holding period at a minimum) and 2) you can afford to re-invest the dividends instead of spending them.

I have done very well in NLY, as an example, even though they cut dividends for a while, simply by re-investing those reduced dividends back into NLY for more stock at the lower price to reduce my cost-basis. Now that both the dividends and the stock price have moved back up - my gain has been VERY good.

Oct 04 01:17 PM

[David Van K...:]

It's fair and helpful to view REITs as a sector, with across-the-board statistics, trends, and conclusions.

But investing in them should be done surgically, one at a time. When examined individually, some REITs do not suffer from the problems affecting the sector generally. For example, while it may be true that "most REITs have mortgages that need to be refinanced soon," there are some that do not, and only company-level analysis will show you which ones. And while some REITs have taken to paying their dividends in shares rather than cash, many still pay cash and show no inclination to revert to paying in shares. Again, more granular research is required to find them.

I agree with mbkelly75: REITs can be terrific investments if you invest in ones with reliable, growing dividends and re-invest those dividends. Over longer terms (measured in years), the total return opportunity is very large. The dividend-only return on cost (that is, the yield's return on your purchase cost) can get into double-digits pretty quickly.

Oct 04 02:50 PM

[Emerald:]

Many of the better capitalized apartment REITs are good investments at today's price. Most have refinanced debt that was coming due 2010-2012 and some have cut dividends to correspond with today's depressed cash flows yet still yield in excess of 4%. Cash flow and dividends will grow and produce a strong total return over the next five years. Long EQR.

Oct 04 06:50 PM