For Mutual Funds, Return on Real Estate Beats That of Stocks
Investment in REITs seen as a defensive move
If the high prices on stock exchanges make you uneasy, there's an option that has done well for investors this year and can be a good defensive play as well: real estate.
Real estate investment trusts (REITs) and mutual funds that buy them have been among this year's notable investment success stories.
REITs, traded on major stock exchanges, own portfolios of shopping malls, apartments, or office buildings. As an investor, whether directly or in mutual funds, you get both a share of the rental or lease income from these properties, and the potential for share-price gains - if the underlying real estate rises in value.
Through Aug. 31, the average total return on REIT mutual funds was 10.41 percent, well exceeding the 7.45 percent for the Standard & Poor's 500 stock index, says Gail Moss, an analyst at Morningstar Inc., a Chicago research firm.
Economic growth helps
Solid economic growth this year has boosted commercial construction projects, land-development ventures, and other real estate-linked financial deals.
Given the recent resurgence in the US real estate market - following a slump in the early 1990s - REITS are expected to turn in solid gains throughout the remainder of the decade, some experts say.
Mark Decker, who heads the National Association of Real Estate Investment Trusts (NAREIT), the main trade group for the industry in Washington, says total return for REITs "could exceed 15 percent this year," perhaps beating the S&P 500 stock index.
The S&P 500 is up 11.9 percent as of Oct. 1. An index of REITs tracked by Prudential Securities in New York had risen 12.2 percent as of the end of August.
Mr. Decker says about 202 publicly traded REITs are actively traded on major exchanges, such as the New York Stock Exchange, the American Stock Exchange, and the Nasdaq market.
The market value of REIT shares now exceeds $100 billion. You can buy or sell shares in a REIT through a stock broker, paying a typical commission.
Rather than investing directly in REITs, however, people with $1,000 to $2,000 to invest can now buy a diversified portfolio of REIT products through mutual funds.
Popular REIT mutual funds include Fidelity Real Estate Fund (14.7 percent total return through Oct. 1), United Services US Real Estate Fund (12.3 percent), Franklin Real Estate Securities Fund (16.1 percent), and Cohen & Steers Realty Shares (15.7 percent through Sept. 30).
REIT products are "good defensive investments," Decker says. Studies have shown that REITs often move independently of the stock market. They can also be somewhat of a hedge against inflation, since real estate is a hard asset.
Lots of new funds
Morningstar monitors 50 REIT mutual funds, and more REIT funds continue to be established (Morningstar counted some 21 funds at the end of 1994).
Total assets in REIT mutual funds have grown 45 percent since the end of 1995, to $3.2 billion.
Legislation allowing REITs was signed into law by President Eisenhower in 1960.
The appeal of REIT funds stems from their combination of high yields, plus price appreciation, Moss says. For example, of the 12.2 percent total return on the Prudential REIT index as of Aug. 30, 5 percent of the gain was from interest yield.
One caution: Real estate accounting procedures can be enormously complicated, says Morningstar analyst Cebra Graves. Thus, traditional measurements such as dividend yields and cash flows may be questionable in the case of REITs. And instead of the price-earnings ratio - a common tool analysts use to judge stock valuations - REIT analysts compare share prices with an accounting number called "funds from operations."
Moreover, REITs can be volatile because of their sensitivity to changes in interest rates.
A few tests can be helpful, experts says, in picking a REIT investment:
*Are the underlying assets, such as land and buildings, likely to hold their value over time?
*Does the management have a proven track record?
*Are the investments diversified or focused in a geographical area or in certain enterprises, such as malls? (Then you can assess long-term market trends.)
*Is the ratio of share price to funds from operations appealing relative to other REITs and to stocks in general?