REITs a Good Play as Real Estate Market Recovers

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Investors should consider REITs as the broader real estate market recovers. As the economic recovery gathers steam, real estate trusts should show better yields and pricing if and when the housing market definitively recovers.

A Brief Primer on REITS

Investing in REITs lets individuals get into the real estate market without actually owning property. A real estate investment trust is a security that sells like a stock, and invests in real property or the underlying mortgages.

REITs can be purchased either directly on one of the major exchanges, or by investing in a mutual fund focused on public real estate. These trusts invest in shopping malls, office buildings, and apartments, as well as senior care facilities, hotels and even warehouses. Some REITs invest in specific sectors, regions, states, or other countries.

While owning individual properties might seem appealing, there is a downside to being a landlord. Besides the obvious pitfalls of landlord/tenant issues, owning property means financing it with a mortgage, plus property taxes and insurance costs. You need to ensure enough rental income to cover those expenses. Ultimately, owning investment property is a complicated endeavor.

So REITs might be a better way to go for investors hoping to benefit from the overdue market recovery. Moreover, REITs receive special tax considerations and potentially offer high yields in the long run.

Types of REITs

Basically, there are three types of REITs: equity trusts, mortgage trusts and hybrids. Equity REITs invest in and own properties – the equity is the value of the real estate assets. Revenue is derived from rental income. 

Mortgage REITs invest in mortgages. These vehicles make mortgage loans to property owners or purchase existing mortgages. Mortgage trusts also invest in mortgage-backed securities. Revenues are generated primarily by the interest earned on the mortgage loans or from residual interest or net interest margins on mortgage securitizations. 

One caveat: These trusts are a bit more complicated than equity REITs. And since bad mortgage paper and mortgage-backed securities triggered the 2008 economic crisis, retail investors with low risk tolerance should probably steer clear of these products.

Finally, hybrid REITs combine the investment strategy of equity and mortgage trusts by investing in both properties and mortgages.

REITs to Consider

The real estate sector's enjoying its strongest gains in the commercial and multifamily markets. So investors should look at REITs that invest in commercial properties like shopping malls and office buildings, or trusts that invest in multifamily dwellings like apartment complexes.

For example, Taubman Centers (NYSE: TCO) owns, develops, acquires and operates regional and super-regional shopping centers in the U.S. and Asia. TCO focuses on retail malls with high sales productivity – measured by the mall tenants’ average sales per square foot. Retail outlets in these plazas target high-end upscale customers which maximizes their profitability. So TCO garners premium rents for its portfolio, which ensures steady growth. Finally, analysts note that Taubman has strong balance sheets with adequate liquidity.

One REIT focused on the multifamily sector is BRE Properties (NYSE: BRE). This is a $3.78 billion residential REIT that invests in multifamily apartment communities.

BRE currently yields 3.20% annually with dividends paid quarterly. Its 3.2% yield outperforms Treasury yields, which currently hover around 1.7%. Although the trust’s price fell in February to a low of $46.74, it has since rebounded to about $48 per unit.

Finally, the Vanguard REIT Index ETF (NYSEMKT: VNQ) offers investors access to the broader REIT equity market. VNQ is actually an exchange traded fund that tracks the MSCI US REIT Index. Its holdings include highly regarded outfits like Simon Property Group and Public Storage. It is currently trading at about $72 per unit - a gain from about $60 over the last 52 weeks. The ETF's dividend yield is 3.39%.

In the final analysis, REITs have a history of providing high levels of income and long-term unit price appreciation. REITs also offer investors inflation protection as well as diversification. Other analysts might argue that current REIT prices are too high and yields are below average. However, as the real estate market improves, REITs can be part of a long-term investment strategy.

Kyle Colona has no position in any stocks mentioned. He is a freelance writer from the New York area with a broad background in legal and regulatory affairs in the finance sector. His extensive body of work is accessible on the web. Mr. Colona is not a financial adviser. This article is for informational purposes only and should not be construed as financial advice.

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