REITs in Review: Real Estate Trends and the Overall Economy

| About: Home Properties, (HME)

REITs have had an excellent rebound from the March lows (as have most stock groups). The Dow Jones REIT Index more than doubled by September, then pulled back 15%. Since then it has rebounded 15% but has not been able to take out its earlier high (but as of December 14, it needs only 2 points).

REITs were market leaders for 7 months when investors were embracing risk, but since then have been laggards even though investors continue to accept risk for bigger rewards.

Other high yield groups continued on their winning ways. The Alerian MLP Index keeps setting new highs (up 15% since September and up 100 YTD) and junk bond funds are at their yearly highs (many have more than doubled from their depressed lows in early 2009). I think the recent flattish range bound pattern for the REIT index describes the underlying economy better than euphoric gains for MLPs and junk bonds. The question is whether the muted record of REITs or the enthusiastic response for the other two sectors will be a better predictor of where stocks are going?

One simple division for REITs is commercial versus residential. Commercial REITs rent properties to businesses (malls, shopping centers, offices, etc.) and have been struggling with higher vacancy rates. Their future will be dependent on a strong recovery in the economy to limit damage from high vacancy rates. Stock markets have only been giving so-so chances for those REITs in recent months.

REITs investing in housing (i.e. apartments) have done much better getting through the recession. They also have to cope with higher vacancy rate, however Fannie Mae and Freddie Mac working with them have been a big plus.

I invested in a prominent housing REIT 11 years ago. Home Properties (NYSE:HME) had a direct investment program to buy shares free of commission and at a slight discount. The dividend has been raised yearly and dividends have grown 40%. Although 2009 is the company's 15th consecutive year of higher dividends, this year qualifies because the quarterly rate of 67¢ increased last year and was paid in all four quarters of 2009. The dividend provides a 6% yield. As with many REITs, a portion is not taxable or taxed at a reduced rate. Last year about half the dividend was taxable income, about 1/4 was taxed at lower (capital gains) rates and the rest was not taxable or classified as an unrecaptured 1250 gain. I bought my shares under 25 and today they are 45 so, including reinvested dividends, the investment has more that tripled.

HME has a good record of growth and has been upgrading apartment properties in two ways. First, it sells properties with lower returns and reinvests in properties offering greater growth potential. Second, it upgrades apartments with improvements after tenants move out to significantly improve the property's rental income. The company's vacancy rate was only 5% in 2008.

The past is only history and the future is uncertain, but HME has an excellent track record, which is always encouraging.

Disclosure: long HME