Although the once torrid growth in the value of land and office space has slowed down lately, there's no question that real estate investment trusts (REITs) have been at the head of the asset allocation class since the spring of 2000. REITs gained an average of 3.6 percent last year, a number that won't set investors' hearts aflutter-until you consider that the S&P 500 Index lost 22 percent over the same period. The gap between REITs and stocks, which was even wider in 2000 and 2001, narrowed but did not disappear in the first quarter of this year.
If you're thinking of REITs as one of the last safe havens from the bear market, however, think again. Even with the war in Iraq in the rearview mirror, businesses are cautious about expanding into new and bigger office space. So vacancy rates are edging higher, and rents are slipping lower, which is not the rosiest of scenarios for investors in commercial real estate. The sluggish economy has put a lid on rental increases for apartment owners, too, and mall development companies are dependent on consumer spending picking back up in the near future.
Put it all together, and the glory days may be over for REITs as far as this investment cycle is concerned. "There is a risk that you won't get an increase in [real estate] demand later this year and into 2004, even as the economy comes back," says Ralph Block, REIT portfolio manager for Oakland, California-based Bay Isle Financial. "If you don't get an increase, you'll see an awful lot of office and apartment REITs paying more in dividends than they get in rent."
The result could be especially painful for investors who count on REIT dividend yields, which average a juicy 7 percent. The last time the industry struggled, in the late 1990s, a number of REITs cut or suspended altogether their dividend payments. Stock prices fell more than 80 percent in some cases.
Not all REITs are created equal, of course. Regional mall operators, for example, may fare better in this climate than REITs focused on office or apartment buildings. But Block says chasing returns in real estate is no easier, or smarter, than chasing returns in technology stocks. He recommends deciding what percentage of your portfolio should be allocated to real estate and leaving it that way. "If you believe in REITs as a long-term proxy for real estate and a good portfolio diversifier," he says, "I don't see any need to change your allocation based on the headlines of the day."
Scott Bernard Nelson is a financial writer at The Boston Globe.