Real Estate Investments Raking In Cash

Real estate investments have bested the Standard & Poor’s 500 stock index for six straight years and are off to another strong start in 2006, reports today’s San Francisco Chronicle. On average, real estate funds returned 13.74 percent in the first financial quarter of this year, beating every other category of domestic stock fund tracked by Morningstar.

Since 2000, real estate funds have an incredible cumulative return of 237 percent, absolutely annihilating the S&P 500, which has lost 2.82 percent, Skeptics have been predicting the fall of the housing market (and with it, investments in real estate) for years, and one day, it will happen. But it doesn’t look imminent, that’s for sure. Consider the following:

• Real estate funds invest primarily in commercial real estate, which marches to a different drum than housing, which is showing signs of slowing.
• Most real estate funds invest the majority of their assets in real estate investment trusts (REITs). These are companies that own/manage commercial properties such as apartments, shopping centers and offices.

Some funds invest in home builders and mortgage REITs, which buy securities backed by residential home loans. These investments are more correlated with the housing market. Most REITs specialize in a particular type of property and/or geographic area, so buying a real estate fund is a good way for small investors to diversify their real estate holdings.

Unlike most stocks, REITs are required to pay out about 90 percent of their income each year to shareholders in the form of dividends (however, these dividends do not enjoy the same low tax rate as regular stock dividends). The total return from a REIT consists of its dividend plus or minus the change in its share price.

• In the late 1990s, when tech stocks were posting double- and triple-digit gains, nobody wanted REITs, which then yielded around 7 or 8 percent.
• Real estate mutual funds trailed the S&P 500 by 44 percentage points in 1998 and by 24 percentage points in 1999, but then the tech market plummeted.
• Since 2000, however, investors have been stashing their money anywhere but tech and growth stocks, and a lot of it has gone into real estate. Many pensions and institutional investors began investing in real estate as part of a long-term strategy to diversify into a new asset class.

“Almost everyone who invests in a wide range of products has set aside 5, 8, 11 percent to be invested in real estate. Everybody has not filled the bucket they assigned to real estate,” Jack Doyle, property data analyst for Global Real Analytics, said.

The global real estate market has responded in kind, with many foreign investors have jumping on board as well. Because diversifying is so desirable, people across the world are are buying U.S. real estate. By the same token, many large U.S. investors are moving part of their real estate money overseas.

“What we have been seeing is a reallocation worldwide of investment portfolios to include commercial real estate,” said Michael Grupe, an executive vice president with the National Association of Real Estate Investment Trusts.

As long as this continues, Doyle says, REITs and REIT funds can continue to go up. While still formidable by any measure, the dividends from these trusts are not what they once were. The average REIT dividend is only 4.5 percent today, down from 7.71 percent at the end of 2000. That decline has made some investors worry that REITs are overpriced. Many are worried that a sharp rise in long-term interest rates could hurt REITs and real estate funds because yields on bonds could start looking more attractive.

As for residential real estate, the vultures are not circling despite a recent rise in Florida home loan rates. Many markets are overvalued and investors are wary of what the market may do in the coming months. But don’t expect a cataclysmic fall, particularly in areas such as Florida, which remains a prime second-home destination. As long as Florida home loans can be obtained between 6 and 7 percent, there should be healthy demand.