By John Wasik
CHICAGO, July 24 (Reuters) - While there’s some debate over whether the U.S. residential market is in recovery mode, there’s a stronger case for a rebound in commercial properties.
Real Estate Investment Trusts (REITs), which invest in a variety of income properties and mortgages and are listed on stock exchanges, often serve as a bellwether of consumer and commercial economic activity, as they will show earnings growth in a general recovery.
Aside from the economic recovery narrative, REITs make sense for investors who are hunting for yield. Although REITs often march in lockstep with stocks during recessions, they can move in different cycles, dictated by movements in commercial real estate. REIT managers also are able to buy more properties when interest rates are low.
REIT exchange traded funds have recovered smartly over the past three years. The S&P Global REIT index, which includes properties from developed and emerging markets, was up 12.56 percent year-to-date through July 23. That compares to 8.67 percent total return for the S&P 500 stock index during the same period.
That lends credence to the theory that the U.S. and developed countries are slowly limping toward an upturn - at least in property markets. A stronger economy and job market translates into more people shopping, renting, traveling and moving - and storing their stuff.
A large portion of the residential gains may be due to increased building of apartment buildings as more people have decided to rent rather than own. Increased commercial building doesn’t precisely track general economic activity, but it may indicate that investors are more confident. And increased travel activity helps the hospitality industry.
There’s a range of exchange-traded or mutual funds that invest in real estate stocks and REITs. For instance, some REITs specialize in just shopping malls and retail outlets. But while you can find a REIT that specializes in any property sector from apartment buildings to health care, I recommend portfolios that invest in a variety of properties.
Diversified REIT ETFs can give you a sampling of real estate from across the world. The SPDR DJ International Real Estate ETF , with a 4 percent yield, invests globally. The First Trust S&P REIT Index concentrates on U.S. properties. Still skittish about the American market? Then consider the Vanguard Global ex-U.S. Real Estate ETF that invests globally and avoids the American market.
REITs must distribute nearly all of their taxable income to shareholders. They are traded as stocks on exchanges, but hold multiple properties in their portfolios. Some are highly diversified while others may focus on a specific sector such as warehouses or office buildings.
For income investors, REITs offer higher yields. The yield on the Vanguard REIT ETF was 3.25 percent, for example. In contrast, the US 10-year Treasury note has been yielding under 1.5 percent lately.
A note of caution: REITs are no substitute for bonds that you hold to maturity. Their returns are not guaranteed and they can be just as volatile as stocks. They declined in 2008 and early 2009. If the recovery scenario does not play out, they could drop in value again.
Be particularly careful with non-listed or “private” REITs, which are typically sold through brokers and contain high fees. Regulators have been scrutinizing them over the past year. I recommend avoiding them unless you have them fully vetted by an independent adviser such as a certified financial planner, accountant or chartered financial analyst.
One more wrinkle: Lately the U.S. bond market has been reflecting the possibility of another economic slowdown and euro zone angst - 10-year yields are still near all-time lows - so be careful. REITs are best for long-term investors who plan to hold them. They should comprise no more than 10 percent of your income portfolio. Property cycles can be just as fickle as general stock market movements and take many years to play out.