So you want to get into the real estate investment game without having to pick up a plunger to unstop a toilet when your tenant calls in the middle of the night.
Your best bet might be a real estate investment trust, or REIT.
Like bonds, the key to REITs is the non-correlation of the underlying assets compared with the daily ups-and-downs of the equities market.
“If the stock market goes down 400 points in one day, will the value of a shopping center go down the same percentage? The answer is no,” said Burl East, CEO of American Assets Investment Management LLC, which manages about $2 billion in real estate investment assets.
REITs are delivering an 8.6% return so far in 2014, compared with the S&P 500’s 1.8% return, according to the National Association of Real Estate Investment Trusts, an industry trade group in Washington. Despite the real estate crash of 2008-2009, REITs delivered a five-year return of 28% , better than the 21% return of the S&P 500 during the same time frame, NAREIT says.
Even better, well-managed REITs are less vulnerable in inflationary times than other alternative investments. “Inflation is real estate’s best friend, so REITs can give you durable, inflation-protected income,” said East, who’s based in San Diego.
Ever since 1960, when REITs were first created in the tax law, they have been growing as an alternative investment to bonds. In 1974 approximately $21 billion was invested in REITs As of 2014, that number has grown to a $757 billion market, according to NAREIT, with $34 billion paid out in dividends.
Because of federal tax rules that require REITs to distribute 90% of their income to investors as dividends, REITs offer a substantial dividend yield, sometimes in double-digits. But like any other investment, if it looks too good to be true (i.e. too high of a yield), it probably is.
“Judging a REIT by its yield is like judging a book by its cover,” said East. “Don’t chase yield. Cash flow, like stocks, is how you value a REIT.”
The downside of course to investing in REITs is just like investing directly in real estate — it’s not an asset you can dump for quick cash when things go south. An exchange-traded REIT can take up to two years to raise money and eight years to buy the property.
“You have to be willing to give up some liquidity and tie some of your money up” for as long as 10 years, said Kevin Finkle, executive vice president of Resource Real Estate, a Philadelphia-based real estate investment firm that manages about $1.8 billion in real estate assets made up of about 25,000 apartment units.
What you get in return if you invest right, he said, is inflation protection. A REIT that has apartment income in high-demand areas at its core can raise rents once a year, every year, and find new renters, Finkle said. “Even in this economy of low interest rates, apartment complexes have been able to raise rents three percent, four percent or more, per year.”
But the costs of getting into non-public REITs are often higher, and a typical investment adviser won’t put more than 20% of a client’s assets into non-public REITs, and even less if their clients are over 70 years of age, said John Funderburk, a financial analyst with the Funderburk Group of Frederick, Md.
“While a REIT offers you protection from rash decisions or big geopolitical events because it’s so hard to get out of one, we still need to protect an investor who doesn’t have a lot of free cash flow from getting locked into an illiquid product,” he said.
Moreover, ETFs don’t offer the same inflation protection, and publicly-traded REITs don’t give you the same non-correlation, Finkle said.