REITs Continue to Look Solid

By Aaron Levitt | March 04, 2011 AAA

Nothing could sum up the global credit crunch and resulting after-effects more than real estate. The broad-based FTSE NAREIT All Equity index lost 19% in 2007 and fell another 41% through 2008. However, since the market bottom, REITs have performed extremely well. The proper mixture of economic and market conditions have helped funds like the Vanguard REIT Index ETF (NYSE:VNQ) surge more than 200% since its March 2009 low. The right combination of low interest rates, available capital and depressed real estate prices have institutional investors flocking to the sector. Many baby boomers in search of inflation protection in real assets and high dividend potential have helped prop up prices.

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Bullish News
The bullish trends for commercial real estate that started in 2010 have continued into 2011. Overall vacancy rates have decreased in all of the 54 largest U.S. real estate markets and in the third quarter, rent growth was positive. This is now the second consecutive quarter of rental rate increases. Office vacancies have declined for the second straight time in the third quarter and sit at just 14.7% and apartment vacancies are a low 7.2%. In addition, higher quality properties are seeing increased rentals. Many renters have "traded-up" to more quality properties due to lower rents created during the economic downturn.

Publicly-traded REITs have also benefited from a zero interest rate environment. Commercial real estate companies have raised more than $150 billion globally in total capital since 2008. REITs have been able to refinance debt or issue equity and use that capital to buy property at cheap valuations. Many new or stalled construction projects are finally being built. For example, Atlantic City's stalled Revel Casino received more than $1 billion in private equity funds to resume construction, and new mixed-use project in Atlanta's Buckhead district has received more than $300 million in financing. In the new low return and low interest world, institutional investors have been looking at ways to protect themselves against inflation and have flocked once again to commercial real estate. The retail investor segment has been attracted to the sector's large dividends as a way to replace lost income.

Finally, the commercial real estate run-up could continue throughout the year. Following each of the three major U.S. downturns since 1973, the resulting seven to 12 year expansion has produced average returns for REITs of 22% per year. Analysts at real estate specialist Cohen and Steers estimate that the U.S. commercial real estate market is only halfway through an expansion phase and has more room to run.

Adding a Touch of CRE
With the real estate market continuing to show some signs of improvement right along with general economy, the time may be right to add the sector to a long-term portfolio. Funds like the SPDR Dow Jones Global Real Estate (NYSE:RWO) allow investors to play a broad spectrum of global real estate. However, there are other ways to gain exposure.

Betting on the continued move of B and C class renters and the rise of quality properties will benefit the iShares Cohen & Steers Realty Majors (NYSE:ICF). The fund tracks 31 of the largest REITs within the United States. Holdings such as mall operator Simon Property Group (NYSE:SPG) and apartment REIT Equity Residential (NYSE:EQR) represent the kind of high-quality deal-makers that will benefit in the future. Shares of the ETF yield 3.37%.

As a play on the strengthening health of both apartment and office real estate, the iShares FTSE NAREIT Industrial/Office Capped Index (NYSE:FIO) and iShares FTSE NAREIT Residential Plus Capped Index (NYSE:REZ) offer investors strategic exposure to these two sectors. Both funds yield around 2.4%.

Bottom Line
As one of the hardest hit sectors during the global financial, the commercial real estate market is making a comeback. The decreases in vacancies, along with new construction, increased rental rates and new capital entering the sector point towards continued growth in 2011. Investors looking to add the sector's larger dividends to a long term portfolio can do so with the iShares Dow Jones US Real Estate (NYSEIYR) or any of the previously listed ETFs. (To learn more, see 5 Types Of REITs And How To Invest In Them.)

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