After being completely obliterated during the financial crisis, commercial real estate rose sharply in the subsequent years as investors sought the sectors high dividends and values. Overall, real estate investment trusts (REITs) managed to provide investors with a 17.8% annualized return from 2010 through 2012. Those gains continued into the beginning of 2013. Then the Fed began its tapering talk. With the potential of rising interest rates on the table, investors have shunned high dividend paying sectors and shares of REITs have plunged in wake of the Fed’s news. Yet, given the commercial real estate sectors long term history of outperformance, investors looking for bargains may want to scoop up shares of operators of shopping plazas, office buildings and hospitals. SEE: The REIT WayBetter Valuations After reaching a six-year high set on May 21, 2013, REITs have plunged about 14.75% since the Federal Reserve provided an update regarding its plans for future bond purchases. However, investors may not want to cast off their commercial real estate holdings just yet in the face of the Fed’s taper talk. That’s because REITs continue to offer plenty of portfolio benefits- and time to buy hasn’t been better. First, the sell-off has made REITs pretty attractive from a valuation standpoint. According to real estate research firm Green Street- the average U.S. REIT is trading at a 10% premium to its net asset value (NAV). That’s more in line with the sectors long-term average. Just a few months ago, REITs were trading at a monster 29% premium to their NAVs. Additionally, REITs strong dividend yields have moved back towards historical averages and still yield a full percentage point higher than U.S. Treasuries. And those dividends are poised to grow even higher over the next three years. Analysts at Merrill Lynch estimate that the sectors weighted average three-year dividend compound annual growth rate (CAGR) will be a strong 7% based on the first-quarter 2013 annualized dividends. The investment bank’s research also showed that REITs could see the possibility of a 12.2% three-year dividend CAGR, if conditions are right. Either way, getting 7% more in dividends each year is certainly appealing- even with rising interest rates. Which shouldn’t matter that much to the REITs. Despite being the reason for their sell-off, commercial real estate has actually done quite well in the face of higher interest rates. Since 1994, there have been 12 periods when the 10-year treasury yield rose 75 basis points or more for a sustained period. REITs have performed wonderfully during this time and have risen 14% on average. That beats the broad S&P 500’s 7.7% returns during the same time period. Bargain Shopping For REITs Given the recent downturn in REIT share prices and the longer term potential, investors may want to add a dose of commercial real estate to their portfolios. The easiest way continues to be through the Vanguard REIT Index ETF (NYSE:VNQ). The ETF spreads its $36 billion in assets among 126 different REITs including stalwarts like mall owner Simon Property Group (NYSE:SPG) and apartment REIT Equity Residential (NYSE:EQR). The fund charges a rock-bottom expense ratio of just 0.10% and currently yields 3.37%. Likewise, the iShares Dow Jones US Real Estate (NYSE:IYR) can be used as proxy for the sector as well. SEE: The Basics Or REIT Taxation While REITs have performed well in the face of rising interest rates, these hikes can affect smaller, less well-capitalized firms. Given that fact, some investors may want to hire active managers to guide their portfolios. Run by Invesco’s (NYSE:IVZ) commercial real estate team, the PowerShares Active U.S. Real Estate (NYSE:PSR) uses quantitative and statistical metrics to identify attractively priced REITs and manage risk. So far, that’s paid off with the fund delivering 29% return since its inception in 2008. At the same time, both the closed-ended Neuberger Berman Real Estate Securities Income Fund (NYSE: NRO) and ING Clarion Global Real Estate Income Fund (NYSE:IGR) currently trade at discounts to their NAVs and offer monster dividends. The Bottom Line The Fed’s taper talk recent squashed some of the euphoria for the commercial real estate world. However, REITs have historically performed well during phases of rising rates. With prices for the sector now depressed, investors have the chance to load up on shares once again. The previous picks- along with funds like the SPDR Dow Jones REIT (NYSE:RWR) –make ideal picks.
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