REITs: Laggards, but for how long?

In this market, looking for bargains is like looking for a good show on local cable at 2:00 in the morning. While commercial real estate isn’t cheap, REITs offer decent yields — and the chance to buy something that hasn’t participated in the latest bull move.

Even though the Standard & Poor’s 500 stock index has gained 18.3% the past 12 months, the real estate sector has risen just 6.1%, according to Morningstar (MORN). Even in the rally this year, buoyed by the prospects of tax cuts and reduced government regulations, REITs have gained just 0.6%, versus 5.9% for the blue-chip index.

What gives? Traditional reasons for REIT underperformance, for a start. The 10-year Treasury note rose from 1.37% in July last year to 2.61% on March 13. Wall Street often sees REITs, like utility stocks, as bond proxies, and bond prices fall when interest rates rise.

The other problem was a happier one: “REITs have been on a tear the past couple years,” said Gregg Fisher, manager of Gerstein Fisher Multi-Factor Global Real Estate Securities Fund (GFMRX). They needed a rest for results to equal expectations, he said. “If you have prices that expect greatness, even if they do great, they could do less than we expected them to be.”

Mr. Fisher, whose fund is split roughly between global and U.S. REITs, thinks the global section of the portfolio might be better performing going forward. The U.S. economic recovery is long in the tooth, and rates are rising. In other areas of the world, such as Europe, the economic recovery is young and rates are still low.

The fund ranks third among global real estate funds the past three years and, as its name implies, is largely a quant fund. The two factors that make the most difference, according to Mr. Fisher:

• Size. As with common stocks, small is often better. Smaller REITs tend to outperform — and to be less-followed by their larger brethren.

• Leverage. REITs that use lots of borrowers often fare well in a rip-snorting bull market. But over a long cycle, leverage hurts on the downside, and makes it more difficult for REITs to borrow when prices are low.

“We tend to dial down risk with leverage and dial up risk with size,” Mr. Fisher said.

As for prices, he looks to relative value.

“We look at things on a relative measure and let the market do the work,” he said.

REITs have the advantage of yield — the typical REIT yields about 4.16%, according to NAREIT, the funds’ trade group, compared to less than 1% for a money market fund and 2.39% for a 10-year Treasury note.

Much of the market’s recent rally has been built on the premise that lower regulation and taxes will send the economy soaring — and President Trump is, after all, a real estate developer. Should those expectations pan out, then U.S. real estate funds might be the way to go. Otherwise, it might be wiser to spread your risks globally.