Real Estate Investing

Now a Safer, More Conservative Proposition

By Kara Stefan

Investing in real estate today isn’t anything like it was 15 years ago–when the market collapsed due to questionable limited partnerships and the old “swampland in Florida” pitch. From the ashes of that debacle rose a smarter, lucrative, and less risky investment, called the Real Estate Investment Trust (REIT).

A REIT is to private developments and limited partnerships what a mutual fund is to stocks. Instead of plunking all of your money into one make-or-break real estate deal, your contribution is spread out among several real estate investments, allowing for diversification. It also allows the smaller investor to participate in large-scale commercial projects.

Not only that, but REITs are professionally managed like mutual funds. And because of the high-flying deals of the 1980s and early 90s, the IRS now strictly regulates REITs.

REIT Structure
Andrew Davis, president of Davis Selected Advisers, L.P. and manager of the Davis Real Estate Fund, believes the best way to describe REITs is that essentially you become a landlord. “A REIT is a low-risk, highly regulated, excruciatingly monitored investment which, in turn, provides a predictable earning stream,” Davis explains.

A REIT is organized as a corporation or business trust and must be managed by a board of directors or trustees–providing the assurance that several people are overseeing the way your investment is being managed. REITs must also have a minimum of 100 shareholders, so you know you’re not in this boat alone.

And finally, the lucrative part of this investment, REITs are required to pay out at least 95% of their taxable income in dividends–which generally translates to a 5-14% yield per investor.

Performance & Risk
Although mainstream media often overlooks REITs, their returns of late haven’t been too shabby. One REIT benchmark, the Dow Jones Equity REIT Index, has returned 18.5% year-to-date–not bad compared to the 10.5% returned by the S&P 500 and a 20.8% drop in the NASDAQ.

Another appealing characteristic of REITs is that they’re considered comparatively low risk investments. In fact, many offer higher yields and lower risk than bonds.

A common measure of risk or volatility is called a beta. For example, if a stock has an extreme reaction to market movement, it has a higher beta. The more speculative a stock or portfolio, the higher its beta. REITs have a beta of .40, compared to 1.00 for your basic stock in the S&P 500. At .40, REITs do not experience wild fluctuations and can appreciate in value during periods of both inflation and economic strength. This is because the underlying property values, occupancy levels, and rental rates may rise no matter what is happening in the rest of the investment market.

The Future Looks Good
Many experts believe REITs are still trading below their potential, forecasting returns 15%-20% higher than their current levels. In fact, now is a great time to jump on board because during the past two years they’ve been overlooked in favor of go-go tech stocks.

Tom Peck, vice president of investor relations at Duke Weeks Realty Corp., one of the five largest REITs in the U.S., says that operationally, REITs are very strong and continue to grow earnings. Unfortunately they haven’t performed as well recently subject to money flows–that is, flowing out of REITs and into technology stocks.

“REITs have a very strong negative correlation with tech stocks,” observes Peck. “As investors started chasing the exciting returns of the tech sector two years ago, we noticed money going out.” However, as the technology market began to slide last spring, investors wised up and rediscovered REITs.

Simple Investment
“Real estate corporations are not that hard to figure out in terms of their complexity,” says Peck, suggesting that they’re ideal for the novice investor because it’s easy to see where revenues come from–leasing. Plus, there are only about 300 REITs in the U.S. today, so the selection is not quite as mind-boggling as the 11,000 mutual funds currently available.

Another nice feature is that getting started at investing can be very easy and cheap. At Duke Weeks, all you have to do is log on to their Web site, read about their dividend reinvestment program (DRIP), and enroll online with an investment as low as $25 a month–which you may arrange to be deducted automatically from your bank account. You don’t need a broker to invest in a REIT. There is, however, another alternative–you can buy REIT shares through a real estate-specific mutual fund. For more information, the best place to start is the National Association of Real Estate Investment Trusts (NAREIT).