Are REITs a smart buy in a recession? It would seem to me that occupancy rates would decrease during times like these.
Part of the argument for investing in real-estate investment trusts, or REITs as they're commonly called, has simply been that the real-estate market tends to move independently of the stock and bond markets, says Jonathan Miller, a principal at Lend Lease Real Estate Investments, a real-estate management company. So when the stock market tanks, REITs (which are publicly traded companies that hold a portfolio of properties) aren't particularly likely to fall with it. For example, last year the S&P 500 fell 10.1% while the Morgan Stanley REIT Index gained 26.8%. This year, the Morgan Stanley REIT Index is up 3.6% year-to-date while the S&P 500 is down 17.4%, says Ken Rosen, chairman of Fremont Real Estate Securities fund (FREFX).
Part of the reason REITs tend to hold up well in bear markets is that they pay out high dividends (averaging around 7.5% these days), which can offer some much-needed cushion. That doesn't mean that REITs are immune to recession, mind you, but many experts believe that there's reason to believe that they'll continue to hold up better than many other investments in the current environment. Real-estate mavens also say the industry didn't repeat its mistake of the 1980s and wildly overbuild office and residential properties during the economic boom of the 1990s, so there's less risk of overcapacity.
While it's true that vacancy rates for all buildings nationwide have gone up to 9.0% from 6.5% over the past 18 months, that rate isn't expected to increase significantly in the near term, since 80% of the properties in this sector are locked into longer-term leases, says Rosen. At the same time, the cost of borrowing money has also gone down, so even if operating profits decrease, REITs are enjoying lower costs on their debt payments, adds Rosen. "For 2002, REITs will not do as well (as they did in 2001), but we don't expect there to be too much value lost," says Miller.
And all REITs are not created equal. The real-estate market is, by definition, local, and there are REITs that concentrate on certain geographic areas. Choosing the right market may make all the difference. For example, while real estate in San Francisco might not be doing so well, real estate in northern New Jersey, particularly office space, might be booming. Mack-Cali Realty (CLI), which focuses on office space in the Northeast, is an example of a REIT that's prospering despite the slowdown.
Some REITs also focus on certain property types -- office, industrial, apartment, retail, hotel, as well as fringe categories like mobile homes and self-storage. REITs that specialize in apartments, particularly in the Northeast and Southern California, could perform well in the coming months, says Miller, due to constraints on home-supply growth in those areas. On the other hand, hotel specialists could be short-term losers due to the slowing economy and fears of terrorist attacks.
So how do you pick and choose among these REITs? Probably the easiest way is to invest in a good real-estate mutual fund that's chock full of these things. For our latest picks, click here.