As dot-coms have crumbled, many investors have sought shelter in the world of bricks and mortar via real estate investment trusts, or REITs. These companies operate properties ranging from office buildings and apartment complexes to hotels, golf courses, and even prisons--and they offer high yields, to boot. "People who thought technology was a one-way ticket to heaven are latching on to REITs as a hedge," says New York investment adviser Louis Altfest.
REITs have appreciated 10.5% so far this year, compared with the 6% drop in the Nasdaq composite index and a mere 1% gain for the Standard & Poor's 500-stock index. As a result, mutual funds investing in REITs have become the third-best-performing fund category in 2000, up an average 8.44% as of May 31.
REITs do have a unique appeal. In good times or bad, REITs shell out 95% of their taxable earnings in dividends in return for their corporate tax-free status. The average REIT dividend yield, currently around 8%, is the highest among all sectors. That compares with 5% for utilities and 1.2% for the S&P 500. Combine that with the rich growth in REIT share prices this year, and you get total returns averaging about 15%. This marks a tremendous recovery from REITs' previous misfortunes: After a growth spurt, they lost over 20% of their value in 1998 and '99 amid concerns that they were issuing too much new stock to buy more properties. Also, investors switched heavily into technology. "Just as investors got fearful of overbuilding, the tech boom started to take off," says Ross Smotrich, a REIT analyst at Bear Stearns.
While the earnings growth of REITs has decelerated to 8% annually from 14% in 1997, most observers think 8% is a sustainable pace for the next two years. This means investors can expect a relative degree of security even in the face of rising interest rates. But choosing the right REIT depends a lot on locale.
"Location, location, location" is still the real estate mantra. Rents have exploded on the West Coast and in the Northeast, where the barriers to new supply are high. Cities in those regions have best reflected the economy's resurgence with new jobs, and REITs concentrated in those urban areas have enjoyed a phenomenal rally.
Take a look at the office sector in San Francisco, New York, and Boston, where rents have had a spectacular run. Spieker Properties, a San Francisco-based REIT with a strong presence on the West Coast, especially in Silicon Valley, has gained 29% so far this year. That's hardly a wonder, considering that Spieker has seen a 35% ascent in rents overall. "New leases for some of our Silicon Valley properties appreciated about 100% last year," says co-CEO John Foster.
Of course, the upheaval in the dot-com universe may affect Spieker's business. "Sure, it worries us," says Foster. But he notes that Spieker has leased only 3% of its properties to dot-com companies. "We believe this area will continue to be a hub of innovation and enterprise, so demand will always be there," he adds.
REITs that own property in New York are also favorites. Arthur Hurley, a portfolio manager at SSgA Tuckerman REIT Fund likes both SL Green Realty and Boston Properties. SL Green has a focused portfolio of second-tier office buildings in Manhattan, where a space squeeze allowed the company to renew leases at 35% higher rents in the first quarter. If you want more geographic diversification, consider Boston Properties, the second-largest office REIT, behind Equity Office Properties Trust.
A favorite of REIT mutual funds, Boston Properties, has seen its shares rise 14% this year. It owns office buildings in four of the hottest metropolitan areas--San Francisco, New York, Boston, and Washington. "We are fortunate to be positioned in those tight markets," says CEO Ed Linde, who has been eyeing Rockefeller Center in Manhattan since its 12 buildings were put on the block last month.
Investors may also want to scour the apartment sector. What's alluring about apartments is that any increases in inflation can be quickly passed on to renters, who generally lease by the year. Two favorites are Essex Property Trust, which develops apartments on the West Coast, and Avalonbay Communities, which has units in Northern California and the Northeast. One other reason for apartments' attractiveness is that the housing-affordability index is likely to go down as interest rates and mortgage costs rise. This could make people hold off buying houses and increase demand for apartments.
NET GAIN. Shopping-mall REITs are hot, too. They tumbled to new lows last year as real estate executives worried that e-commerce would hurt retail buying in stores. "But last Christmas, that perception changed as it became clear that the Internet will not have a dramatic effect on malls," says Mike Kirby, a principal at Green Street Advisors, a real estate advisory boutique in Newport Beach, Calif. Among Kirby's favorites is Crown American Realty, which owns midscale malls in the Northeast and, at $5 a share, is trading at a third of its mid-1990s highs. "What's more attractive is its unbeatable 16% dividend yield, which will be sustained," Kirby says.
Kirby also likes Taubman Centers, which, at $11 a share, is trading below its 52-week high of around $14. An owner of upscale malls, Taubman is also trading at a 28% discount to its net asset value. Doug Barton, portfolio manager at the $410 million Franklin Real Estate Securities Fund, has bought shares of Simon Property Group and General Growth Properties. General Growth CEO John Bucksbaum notes that his company has averaged 17%-per-share earnings growth for the past seven years.
Not every REIT is a buy right now. The health-care sector has so far underperformed the REIT indexes because of continued problems among operators of assisted-living and nursing-home facilities, including the high-profile bankruptcies last year of Vencor and Sun Healthcare Group. One REIT, Meditrust, is down 65% this year. But many other REITs offer a solid combination of geographic diversification, reasonable growth, and high yields.