As investors continue to gravitate to real assets and income opportunities, commercial real estate continues to show its metal. The asset class has benefited from the trio of bargain hunting, low interest rates and retirees seeking income over the last year. Funds like the First Trust S&P REIT (ARCA:FRI) have shown positive returns for 2011, and analysts anticipate that the trend will persist into the new year. However, while most investor attention has been toward standard real estate like office buildings, shopping malls and apartments, the real gains could be seen in niche property types. For investors, these specialty REITs could be the key to outperformance in the real estate sector. (To learn more, read How To Analyze Real Estate Investment Trusts.)
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Riches in Niches
Cold storage warehouses, cell phone towers and timberland aren't exactly what most investors look for when they focus on the real estate sector. They can be great investments. Firms that invest in real estate other than the standard groups of office, retail, residential and industrial, have been extremely good performers over the last few years. Unlike the four major property types, these specialty and niche properties feature markets that are not generally dictated by larger macroeconomic trends. The recent economic malaise hasn't really affected underlying performance. For example, the timber REITs can continue to grow their trees when log prices are low and storage centers have benefited from the housing crisis and the shift toward increased renting. Overall, the Dow Jones U.S. Specialty REITs index showed a return of 7.94% for this year. This compares with a 3.32% return for the broad iShares Dow Jones U.S. Real Estate Fund (ARCA:IYR).
Due to the sector's "non-traditional" nomenclature, the specialty REITs are often ignored by mainstream and instructional investors. This can provide deep discounts to book value and outsized dividend opportunities. The sector can also add valuable diversification benefits to a real estate portfolio by providing investors with alternatives they may not have considered. (For related reading, see Diversifying Your Portfolio With Real Estate And Infrastructure.)
Getting Special with Your Real Estate
Adding a dose of niche real estate to a portfolio could be just what investors need to increase diversification and income. However, even though there are a variety of specialty real estate indexes, no broad ETF tracks the space. For investors, that means digging into some individual picks.
Even with the American consumer straining, cheap forms of entertainment continue to thrive. That has benefited movie theater owner Entertainment Properties Trust (NYSE:EPR). In addition to its multiplex operations, the REIT owns a variety of retail, restaurant and other entertainment venues across 33 states. Over the last 10 years, EPR has constantly outperformed both the Russell 2000 and the broad REIT indexes. Shares of the firm yield a delicious 6.5%.
A Boom for Data Center REITs
The explosion of cloud computing and internet-enabled devices has been a boom for the data center REITs. Operating about 98 data centers across North America, Europe and Asia, Digital Realty Trust (NYSE:DLR) is one of the largest wholesale data center providers. Shares of the firm have shot up more than 27% this year and currently yield 4.1%. Analysts anticipate continued growth as more businesses move to the cloud. Similarly, telecommunications firm American Tower's (NYSE:AMT) pending conversion to a REIT provides investors with an additional opportunity to play technology real estate. American Tower expects to pay dividends of 80-90 cents per share in 2012 after it converts.
Finally, timber real estate has been a go-to asset class for institutional investors for several years, and the retail set is finally catching on. Broad-based funds like the iShares S&P Global Timber & Forestry ETF (Nasdaq:WOOD) allow investors to hit a wide swath of timber companies, while the REIT trio of Weyerhaeuser (NYSE:WY), Plum Creek Timber (NYSE:PCL) and Rayonier (NYSE:RYN) all offer strong cash flows and above-average dividends. (For more information, read Timber Investments Cut Down Portfolio Risk.)
The commercial real estate sector has made great strides since the depths of the financial crisis. However, those real estate firms that operate outside the norm have done better. For investors, these specialty REITs could be the key to real estate outperformance in the future. The previous stocks, along with gas station owner Getty Realty (NYSE:GTY), make ideal selections. (For related reading, see The REIT Way.)
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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.