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Income Investing

The Wide World of REITs — Part 1

By Roger S. Conrad, on Mar. 13, 2015

From Sept. 30, 2014, to Jan. 31, 2015, US real estate investment trusts (REIT) turned in an impressive performance, with the Bloomberg North American REIT Index delivering a total return of almost 20 percent. In comparison, the S&P 500 gained 1.75 percent over the same period.

The capitalization-weighted index of 165 US REITs has dropped 5.8 percent since then, underperforming the S&P 500.

Much of this downside reflects profit-taking by investors amid heightened concerns that rising interest rates will erode the future value of REITs’ dividends. Like Pavlov’s dogs, individual investors and institutional money managers have been conditioned to sell dividend-paying stocks when rumors of rising interest rates circulate.

Here’s some perspective: The Bloomberg North American REIT Index has more than tripled since bottoming on March 9, 2009, and yields about 3.6 percent—about 50 basis points less than at the group’s peak valuation in early 2007. The index also trades at 2.62 times book value, somewhat less than the 2.91 registered at its previous top.

The group was due for a breather. Now, income-seeking investors must weigh whether the recent pullback marks a temporary setback or the start of a larger downtrend.

The 2007-09 crack-up belied the notion that REITs were basically utilities that owned property. Many names haven’t recovered fully from this meltdown, which was brought on by years of excess leverage and real estate values that stretched beyond the bounds of reason.

Only a handful of US REITs—mostly niche players in multifamily housing—managed to avoid dividend cuts.

But the recent slide in REIT stocks appears unlikely to translate into a calamity of this magnitude; the excesses of the last blow-up have kept a lid on leverage levels and risk-taking, and we don’t foresee a global crisis that freezes the credit faucet.

And despite all the sound and fury about the Federal Reserve raising interest rates and its implications for dividend-paying stocks, borrowing costs likely will remain low (relative to historical norms) for some time.

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