These days, skeptical investors have every right to put "a winning real estate investment" right up there with "a bridge in Brooklyn." But a surprising corner of the market real estate investment trusts have been surging, making money for anyone who can get past those first two words.
In spite of the worst real estate market in decades and a recent market shake-up, REITs have still soundly beaten most other investments. Year-to-date, U.S. REITs are up 7.3%, versus a 2% return for the Standard & Poor's 500-stock index and more than double the performance of the Barclays Aggregate bond index. Investors have noticed, plowing almost $22 billion into newly-issued REIT shares during the first five months of the year, almost triple the amount last year at this time. For interested investors, companies have responded with increasingly niche offerings: a campus housing REIT launched late last year; a REIT that leases space to cell phone operators and broadcasters will launch later this year.
Credit commercial real estate. Office buildings, apartment complexes and other commercial buildings haven't seen the same sustained slump that the residential market has; the supply is tight as the economy shows signs of recovery, and rents have gone up. Apartment REITs in particular have flourished, up 13% this year, as young adults move out of family homes, would-be home buyers delay a purchase, and home owners displaced by foreclosure look for alternatives.
But critics say investors have good reason to be cautious. The recent market tumult brought on by the Greek debt crisis hit REITs along with the rest of the U.S. markets, causing around a 4.5% drop this month. Over the longer term, rising interest rates may be the bigger threat to REIT investors: They make real estate loans more expensive, which can hurt the underlying investments held by a REIT. "There's a lot to be worried about," says Jeff Sica, president and chief investment officer at Sica Wealth Management who advises real estate owners and developers among others. And rising yields on bonds offer competition to dividends on REITs.
Even with these risks, REITs have been remarkably resilient, analysts say, managing to outperform both when interest rates rise and when they fall. Over the past three decades, the annual rate of inflation averaged 3.1%, while REITs' total annual returns, including dividends, averaged 10.5%. Rents also tend to rise with inflation, which is why many investors flock to REITs as an inflation hedge. Those increased rents get passed through to shareholders; by law REITs must pay at least 90% of their taxable income rents less expenses to their shareholders.
Rather than paying top dollar for yesterday's top performers, Philip Martin, REITs strategist at fund-tracker Morningstar, suggests looking at narrow categories, like health care and some specific niche retail, where consumer demand is less sensitive to the economy. Health care REITs, which include a combination of senior living communities, assisted living facilities and medical office buildings, are expected to see growing demand partly from aging baby boomers and due to longer life spans. Martin recommends Health Care REIT (HCN),