REITs Still Offer Shelter from the Storm
Favorable industry fundamentals, strong balance sheets and a stabilizing US economyhave combined to make real estate an attractive asset for investors, whose portfolios should continue to benefit for some time.

Publicly traded U.S. REITS, fully known as real estate investment trusts, — with combined market capitalization of more than $500 billion — have outperformed the broader stock-market, although investors would be wise to choose holdings based on sectors, geographic markets and company quality.

The FTSE NAREIT All REITs Index also outperformed the S&P 500 over the past three years, with nearly 28 percent in average annual returns, compared with roughly 14 percent for the S&P 500, as of July 31. Annual returns over five years averaged some 4.5 percent for the REIT index, versus 1 percent for the S&P 500.

Low interest rates, rising rents, strengthening demand and limited property supply bode well for REITs, which appeal to investors as relatively safe havens that represent real assets and provide solid dividend income. REITs typically invest in apartments, office buildings, hotels or other property types.

“We like the growth and income story that REITs offer investors,” Philip J. Martin, Morningstar’s director of REIT research and strategy, said. Morningstar, though, believes REITs are trading at a 10-percent to 15-percent premium to fair value, with multifamily housing companies at a 20- percent to 25-percent premium, healthcare REITs at fair value and other segments somewhere in between.

“We’re being very selective in terms of business model, in terms of portfolio, in terms of location,” Martin said.

Improving Fundamentals

Balance sheet strength and dividend growth potential will be differentiating factors for REITs, which need to show they can weather economic uncertainty and dislocation and increase their dividends to outpace rising interest rates and inflation, he said.

Steve Shigekawa, Neuberger Berman managing director and real estate fund co-portfolio manager, said his firm’s outlook for investing in REITs remains favorable primarily because of improving fundamentals.

The firm believes REITs diversify holdings and enhance returns in investor portfolios, giving shareholders exposure to real estate.

In addition, REIT dividend yields are attractively valued now compared with fixed-income alternatives, such as U.S. Treasurys, one factor that may be driving stock performance, Shigekawa said. In 2010, REITs provided investors with $18 billion in dividends, according to the National Association of Real Estate Investment Trusts.

While macroeconomic and political uncertainty persist near term, “our long-term view is positive,” Shigekawa said, adding that REITs with strong balance sheets should weather market downturns.

It’s relatively easy to play the economic cyclewith REITs, Morningstar’s Martin said, noting that investors in a defensive mode can lean to less cyclical sectors like healthcare REITs and shift into office, industrial or lodging as the economy improves.

Neuberger’s Shigekawa noted that economic growth and job creation are growing, albeit modestly, which appears to be driving demand for commercial real estate, including office buildings, apartments and industrial assets. Demand for commercial real estate versus the supply coming online is favorable for landlords, he said, explaining that supply across property types remains near historic lows.