REITs pay off for investors

As Americans moved to rentals, self-storage facilities led the pack in 2011 with a 35.2% return

Jan 15, 2012 @ 12:01 am

By Jeff Benjamin

The nation's housing market still may be struggling, but don't rule out investment opportunities in real estate. Last year, real estate investment trusts, as measured by the FTSE Nareit All REIT Index, gained 7.3%, more than three times the 2.11% return of the S&P 500.

For many REIT investors, the primary appeal is income, which represented nearly two-thirds of the broad REIT index's total return last year.


Even though 2011 paled by comparison with the previous two years, when the REIT index gained more than 27% annually, REITs offer solid arguments for investing.

“Unlike a bond that has a fixed coupon, REIT dividends have the potential to grow with increased cash flow,” said Ritson Ferguson, co-portfolio manager of the $3 billion ING Global Real Estate Fund (IGLAX).

“Real estate's natural appeal is even more obvious in a [sluggish economic] environment like this,” he said. “If you can buy a 4% dividend where the income is expected to grow by 7%, why wouldn't you do it?”

Several trends favor the broader REIT market and help it appear attractive on a relative basis, but it is the underlying subcategories that truly illustrate how and where real estate is attractive.

The self-storage subcategory, which gained 35.2% in 2011, stood out as the most logical winner among REITs.

“The strength of self-storage REITs shows the defensive demand characteristics,” said Rick Romano, manager of the $800 million Prudential Global Real Estate Fund (PURAX).

Self-storage facilities, he said, are directly benefiting from the “dislocation” in the housing market as more borrowers walk away from their mortgages, or are forced to move because of foreclosure, and have to put at least a portion of their possessions in storage.

Along the same lines, apartment REITs also have benefited from the steady realignment in homeownership across the country.

The apartment REITs category gained 15.1% last year as vacancy rates continued to fall and property owners enjoyed some renewed pricing power.

And according to the National Association of Real Estate Investment Trusts, that trend is still headed in a positive direction.


Nareit calculated vacancy rates for multifamily-housing properties at 9.8% at the end of the third quarter, down from 11.1% at the end of 2009, though still above the historical average vacancy rate of 8%.

“We have seen the realized demand as people have moved into rental properties, but the pent-up demand will lead to a strong increase in multifamily-housing construction starts,” said Calvin Schnure, vice president of research and industry information at the association.

“A lot of things slow down in a recession, but one thing that doesn't slow down is population growth,” he said.

The normal development resulting from demographic events such as marriage, divorce and young people's moving out of their parents' homes historically has led to an annual increase in housing formations of 1.3%. But through the economic downturn of the past four years, new-housing formations have grown by less than 0.5% annually.

These kind of data add up to significant pent-up demand for housing, Mr. Schnure said.

“We're going to see about 3 million new households unfold over the next two or three years,” he said. “That means rising occupancy rates for REITs.”

Homeownership in the United States, which peaked at 69% in 2006, has since fallen to 65%, which is in line with historical averages.

But in the context of a gloomy economic outlook, there is a very real possibility that homeownership levels will continue to fall.

“We could certainly go below that [65% ownership] level, because there are really no catalysts in place to turn it around,” Mr. Romano said.

Even if he isn't entirely optimistic, the macroeconomic data for REITs are positive, Mr. Romano said.

For example, construction starts of multifamily-housing units are equal to 0.5% of existing supply, which is a quarter of the historical average of 2%, he said.

“It's difficult to have any real conviction about where demand will come from, but the apartment demand drivers are in place,” Mr. Romano said. “The [collapse of the] single-family-housing market has definitely contributed to the success of the rental space.”


One of the REIT categories that has been an unexpected surprise for market watchers is regional malls, a subcategory of retail, which is dominated by public REITs.

Its 22% gain last year was a testament to the resolve of consumers, according to Brad Case, Nareit's economist.

“At this point, there is no reason to think there will be a pullback in consumer spending,” he said.

Some of the other strong- performing categories last year were health care REITs, up 13.6%, and manufactured homes as a subcategory of residential housing, up 20.4%.

Of the 13 categories of equity REITs, nine finished the year up.

The biggest laggard last year was the lodging/resort category, which declined by 14.3%.

“Hotels are extremely sensitive to the overall economy, and people are still really concerned about the global economy,” Mr. Case said.

Unlike most REITs, which can lock in longer-term leases to help weather economic volatility, hotels often are forced to lower room rates in stride with the economy. That also makes them stronger performers during economic upturns.

Mortgage REITs are unique from equity REITs in that they don't own property but essentially are finance businesses that buy mortgages and sell debt.

Although mortgage REIT dividends are producing impressive yields of beyond 14%, the category is seen as vulnerable to macro forces such as the European financial crisis and the potential for rising interest rates, which is why the category declined by 2.4% last year.

“The risk related to mortgage REITs is [that] they come with quite a bit of leverage,” said Christian Hviid, managing principal at Point Guard Capital LLC.

Mr. Hviid takes a contrarian view of several equity REIT categories.

“I believe job demand will pick up in 2012, so I think office space REITs will give you the most bang for your buck,” he said of the category, which declined by 0.8% last year.

Ultimately, against the backdrop of a muted run for equities and a forecast for sluggish economic growth, the market is embracing REITs.

Through November, REITs raised a record $37.3 billion through equity offerings, which beats the previous record of $32.7 billion raised during all of 1997.

The new money helped to push the leverage for equity REITs down to historical average levels of 41%. That leaves the industry well-positioned to manage many of the five-year loans established during better times and that are coming due in 2012.


What do you think?

View comments

Upcoming event

Oct 22


San Francisco Women Adviser Summit

The InvestmentNews Women Adviser Summit, a one-day workshop now held in six cities due to popular demand, is uniquely designed for the sophisticated female adviser who wants to take her personal and professional self to the next level.... Learn more

Most watched


Young advisers envision a radically different business in five years

Fintech and sustainable investing are two factors being watched closely by some of the 2019 class of InvestmentNews' 40 Under 40.


Schwab's Jeff Kleintop: Prep for volatility given China trade uncertainties

China could be considered a developed market in five to seven years , according to Jeff Kleintop, chief global investment strategist, Charles Schwab.

Latest news & opinion

TIAA exits the life insurance business

The move is a big deal for RIAs, experts say, since TIAA was one of only a few insurers to offer fee-only life policies.

Advisers step up efforts to help clients manage student loan debt

As some Democrats campaign to wipe the slate clean, financial planners focus on limiting the amount students borrow.

Funding for Reg BI, other SEC advice reform efforts denied in Waters amendment

House likely to approve measure that effectively kills rule package, but it faces uphill battle in Senate

Wall Street lashes out at Sanders' plan to pay off student debt with a securities trading tax

Financial pros argue that a transaction levy will hurt mom-and-pop investors along with investment houses.

GPB paid B-Ds and reps steep commissions to sell troubled private placements

GPB paid commissions of 9.3%, or $167 million altogether, on the firm's private placements.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print