Don't Consider REIT a Four-Letter Word: These Few Should Outperform

by: Andrew Mickey

Who says real estate is dead? Sure, houses are staying on the market longer and the ability to "flip" a house or condo for 30-50% profits in a few months seems like a bygone era, but real estate isn't dead. In some cases it's doing better than ever, and savvy investors are pocketing housing boom-style gains without all the liquidity risk of personally buying real estate. Let me explain.


In the last few months, big-time investment companies have been steadily paying top dollar for companies in one industry and doing most of it under the radar screens of many investors. Now, an all-out battle has ensued to sustain growth, generate cash flows and get an inside look into a complicated industry that many left for dead just a few months ago, while creating a solid trading opportunity.

Just look at some of the figures. Morgan Stanley (NYSE:MS) just announced it would be investing more than $1.5 billion directly into this industry. SL Green Realty (NYSE:SLG) will be expanding its exposure to this market by $4 billion. And Merrill Lynch (MER) stated it is "looking to buy similar businesses because [this industry] was a priority at the firm."

These companies with billions of dollars ready for investment are vying for direct exposure to office Real Estate Investment Trusts (REITs). I know "REIT" has been a four-letter word around the investment community over the last couple months, but there's been a startling rise in the number of acquisitions that you won't want to miss out on.

The housing market may be crumbling, but the office and retail real estate markets are just as strong as they ever were... and getting stronger. Once the Fed proved it would raise rates steadily and had no intentions of slowly deflating the housing bubble, REITs began to show their first signs of weakness just five months ago. Back in March, only whispers of a housing decline were mentioned and Wilshire's REIT Index ETF (NYSEARCA:RWR) was continuing to set new highs when it hit $79.2 per share. But the good times would soon be over.

A slew of bad news for the real estate industry about rising housing inventories, sizable declines in luxury homebuilder Toll Brothers' (NYSE:TOL) profitability, and residential real estate staying on the market for months sent many investors running from REITs. In the process, Wilshire's REIT Index ETF fell more than 11% in less than two months.

The weakness, however, was a bit misguided. It was all just overblown fear in the markets. Now, following the brief correction in REITs and the resurgence in Wilshire's REIT Index ETF back to $80 per share, Wall Street's big money has been buying them up and paying some hefty premiums.

Morgan Stanley has recently tendered offers of $838 million for Glenborough Realty (GLB), an 8.2% premium, and $706 million for Saxon Capital (SAX), a whopping 29% premium. Clearly the big money is buying strong if it's willing to pay those kinds of premiums. In my book, that's a multibillion-dollar vote of confidence that can't go unnoticed.

Over the near term, I would expect Merrill Lynch and Lehman Brothers to jump on the REIT buying spree. These two companies have been buying REITs for years, repackaging them as mortgage investments for private and institutional clients, and turning a tidy profit in the process.

Lately, office REITs have been trading up today on takeover speculation. Two REITs ripe for the picking are Maguire Properties (NYSE:MPG-OLD) and Parkway Properties (NYSE:PKY). Takeover speculation is running rampant. Both stocks, which are engaged primarily in office and retail leasing are hitting new 52-week highs.

I'd stay away from stocks like these because the office properties and the REITs that track them are overvalued, and I'm not the only one who feels this way. Executives at Equity Office Properties Trust (EOP) have decided to unload $3.5 billion worth of office properties. That's about 15% of the firm's revenue-generating properties.

If you want the income generated by REITs, you should look at diversified and healthcare facilities REITs. My favorite diversified REIT is Investors Real Estate Investment Trust (NASDAQ:IRET). The company owns a well-diversified portfolio of properties including residential, office, medical and retail properties. This stock is quick and easy way to get exposure to real estate and is doing well. The company just upped its regular dividend, sports a yield of 7% and has paid dividends for each quarter since 1970.

For long-term investors, though, IRET offers a good deal to dividend reinvestment plan [DRIP] members. If you own shares of IRET and are willing to automatically reinvest your dividend payment, then the company will give you a 5% discount on all new shares purchased. Combine the discount with no commissions and you'll be starting out with 5% paper profits without even taking on any extra risk.

The best of the healthcare facility REITs is Senior Housing Properties Trust (NYSE:SNH). The stock has climbed more than 20% over the past few months and still offers a 6.7% dividend yield. The most interesting part about Senior Housing is that it derives more than 75% of its revenues from private sources. In other words, its customers pay for their own service.

This is certainly not the norm in the healthcare facility REITs industry. A few healthcare REITs depend almost entirely on Medicare payments for their revenue streams. They can't raise rates or maximize profits and cash flows without government approval of higher reimbursements; Senior Housing does not.

On top of that, Senior Housing is a great way to play the demographic shift. As the U.S. population ages, Senior Housing will be soaking up the increased demand for assisted-living facilities.

All in all, if you're looking for steady dividend checks and long-term capital appreciation, IRET and Senior Housing will give you both. If you want to jump in with the greedy crowd and lose money, buy into Maguire and Parkway on the heels of overaggressive, speculative buying while they're trading near their highs.