Is It Time For REITs?

By Aaron Levitt | September 29, 2010 AAA

With so many CDOs, CLOs and the other various alphabet-soup named securities backed by the idea that real estate prices can never fall, it was only natural that real estate was one of the hardest hit sectors during the global credit crisis. The sector saw prices fall by nearly 50%, as it is highly correlated with consumer spending and economic health. With persistent high unemployment and falling incomes, there is still much uncertainty surrounding housing and residential real estate. However, the commercial space is seeing some bright spots and its REITs are starting to look like buys. (The unique tax advantages offered by these investments can translate into superior yields. To learn more, see The Basics Of REIT Taxation.)

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Signs of Improvement
Despite the pressures facing the housing market, the commercial real estate space is looking up. Recently, several bullish signals have manifested themselves within the sector, possibly indicating that the tide is turning. Vacancies in office complexes, retail space and self-storage facilities through July, showed no noteworthy signs of rising. Occupancy rates are much higher than a year ago; with apartment buildings hovering around 92% and office buildings at 84%. As occupancy rates continue to stabilize or even rise, this will help tremendously with REITs' cash flow.

REITs are also seeing increasing demand for their shares from institutional investors. According to the National Association of Real Estate Investment Trusts, REITs completed $21.2 billion in secondary sales last year, the most since 1992. This year, U.S. REITs raised $11.8 billion in secondary offerings. While 2009's offerings were used primarily for "balance-sheet repair," most money raised this year is going towards funding new purchases intended to boost earnings and dividends. For example, Boston Properties (NYSE:BXP) has approximately $1 billion in cash on its balance for acquisitions, and apartment owner UDR (NYSE:UDR) sold shares this month to help pay for a $455.1 million acquisition of five apartment complexes and the development of one more. The volume of commercial property transactions is beginning to rise after previously reluctant owners are willing to sell now that prices have risen.

Finally, REITs and the real estate sector are getting a boost from retirees looking to boost their income. With interest rates still hovering at zero, typically REITs offer dividends greater than treasuries plus the opportunity for capital gains. Back in April, Bond King Bill Gross said that real estate is nearing a bottom and eventually could be a better bet for investors than stocks or bonds.

Adding Some Property
With sales of commercial real estate in the U.S. rising to $36.2 billion in the first half of 2010, up 67% from a year earlier, and healthy demand for REITs' secondary offerings, now may be the time to add a dose of real estate to a portfolio.

The easiest way to add real estate to a portfolio is through the exchange-traded funds such as the iShares Cohen & Steers Realty Majors (NYSE:ICF). The fund follows 31 of the largest real estate operators in the United States and represents a wide swath of property types and locations. The fund is also cheap, charging just 0.35% in annual management expenses and yields 3.11%. Investors could pair this with the SPDR Dow Jones International Real Estate (NYSE:RWX) which follows REITs outside the United States.

Mall operator Simon Property Group (NYSE:SPG) has been the top acquirer of property over the last two years, most recently purchasing Prime Outlets for $2.3 billion in August. Simon still has plenty of cash and has been smart in buying throughout the downturn. Following a "best of breed" strategy, Simon should be on investors' lists.

With our population increasing and aging, healthcare remains a top priority. Health Care REIT (NYSE:HCN) owns and operates assisted living facilities, nursing facilities, hospitals and medical office buildings throughout the country. The REIT recently bumped up a secondary offering by a million shares in response to investor demand. Shares of HCN yield nearly 6%.

Bottom Line
While there is still much uncertainty with regards to the housing market, the commercial space is starting to look up. Recent bullish investor demand on REITs' secondary offerings and stabilization in occupancy rates bode well for the sector. Now may be the time for investors to add some real estate to a portfolio through the SPDR Dow Jones REIT (NYSE:RWR) or the previously mentioned stocks.

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