Americans are moving into real estate at a blistering pace. Only this time, they aren't snatching up McMansions or even fixer-uppers. They are moving into one of the real estate industry's few bright spots: shares of professionally managed property portfolios.
So far this year, investors have poured roughly $6 billion into publicly traded funds of U.S. real-estate investment trusts, or REITs, which mostly buy commercial properties like apartment buildings, office parks and shopping malls. That is up 18% from all of 2010 and 400% from 2009, and a pace unseen since before the financial crisis, according to Citigroup Global Markets.
Though striking, investing pros say the move isn't surprising, given investors' appetite for income. Through October, the FTSE Nareit All Equity REITs index, which tracks property REITs, had a return of more than 7%, including dividends. By comparison, the Standard & Poor's 500-stock index was up 1% and change.
"When almost everything else is down, you usually count on these wild cards to be up," says Lois Carrier, president of Carrier & Maurice Investment Advisors in Johnson City, Tenn.
Still, some advisers caution that isn't always true. The European debt crisis that escalated over the summer hit REITs along with the rest of U.S. markets. Total returns for the Nareit index tanked during the third quarter, falling 15%, compared to the S&P's decline of 14%. Indeed, while sold as a portfolio diversifier, these funds have at times moved in lockstep with the stock market since the market meltdown of 2008, when REITs plunged 38% nearly the same performance as the S&P 500. (Longer term, there is greater separation: Over the past 10 years, property REITs have compound annual total returns of 11%, compared to about 4% for stocks.)
That said, many advisers see plenty of upside in REITs. Some commercial real estate, they point out, hasn't gone through the same prolonged slump as the residential market and in fact recovered a while ago. REITs focusing on apartment buildings in particular have flourished, thanks to tight mortgage lending, renters who have put off buying a house and foreclosed homeowners who are now renting instead, says Aaron Schindler, managing director at New York-based Wealth Advisory Group.
Total returns on apartment buildings and self-storage properties average about 10% and 22%, respectively, year to date through Nov. 9, according to the National Association of Real Estate Investment Trusts.
Since most REITs employ some degree of leverage, they often do well in a low interest-rate environment like we are in now.
But because rents also tend to rise with inflation, REITs can be used as an inflation hedge, says P.J. Gardner, an adviser and founding partner at AGW Capital Advisors, an investment consulting firm. 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.
Those dividends offset some of the risks, especially in the current low-rate environment, says Jeff Sica, president and chief investment officer at Sica Wealth Management, a financial advisory firm.
His more conservative clients have no more than 5% of their overall portfolios in REITs, while more aggressive ones have up to 10%.
"This has everything to do with the fact that there's a hunger for yield," he says.