Problems in the real estate market may make you want to run for the hills, but there are still some investment opportunities to be found. According to Arthur Oduma, a senior equity analyst with Morningstar, the Chicago-based fund research group, investors may want to look at real estate investment trusts, or REITs. He suggests specifically looking at REITs that operate office buildings, industrial parks, shopping malls, hotels, hospitals, and a host of other commercial properties.
REITs own and manage properties and generate earnings from rents and long-term leases. By law, REITs are required to pay out 90% of all taxable income to investors in the form of dividends. Currently, the average annual dividend yield for REITs is 6.3% compared with 2.0% for the S&P 500. Over the past 10 years the average dividend yield has been as high as 7.9% in 1999, prior to last year’s low of 4.0%.
Now may seem to be an odd time to look at real estate because the subprime mortgage crisis has panicked investors of all stripes. Consider that as of mid-October the broad FTSE National Association of Real Estate Investment Trusts (NAREIT) All REIT index was down more than 6% while the S&P 500 was up more than 10%. The good news, says Oduma, is that many well-managed REITs, though positioned clear of the debacle, saw their share prices drop. The upshot: This means that investors have an opportunity to buy sound companies with fat dividend yields at a discounted price.
What qualities do the best REITs have in common?
Solid management is high on the list. When the industry is down like this, we advise investors to look for REITs that know how to pick assets and great locations but that are also skilled at managing cash flow and investing capital. We also look for diversified holdings, because real estate is cyclical. A portfolio spread across regions or various segments of the business sector can often withstand a slowdown in any one portion of operations.
There are market factors that are important, too. We look favorably on companies that own existing property in markets that have barriers to entry–such as the costs and time needed to develop a property–because they help to keep competition from encroaching very quickly. Between zoning clearance and construction time, a large downtown office building or apartment complex can take up to six years to complete.
Which sectors of the REIT universe look the best right now?
We think the industrial sector, which includes companies that own warehouses, cold storage, and distribution facilities, can withstand a slowdown and at the same time benefit quickly whenever the economy turns up in the future. One factor that benefits these REITs is that owners can construct extra capacity quickly–in six months rather than waiting several years to build an apartment complex. There’s a considerable overseas opportunity too, now that the global economy is pushing storage capacity in Asia and Europe. Hospital or healthcare REITs are a group that stands to benefit from the aging of our society.