Playing the property market
You can invest in real estate without buying another home
The family homestead is often the biggest--and lately the best--investment most people make. But what about stocks that provide exposure to other people's properties, from apartment buildings to office towers to shopping malls and hotels? And for that matter, what about stakes in companies that build, own, or supply the real-estate market?
While the surge in home prices has been well documented, less attention has been paid to the breathtaking run-up in housing and real-estate-related stocks in recent years. Over the past five years, mutual funds that invest in real estate have soared 20 percent a year on average, making them the best-performing U.S. asset class. By comparison, the S&P 500 index has fallen more than 2 percent a year during this stretch and the Nasdaq composite index has lost about 9 percent annually. "I'm inclined to think we're going to see another up year in 2005," says Don Cassidy, senior research analyst at Lipper.
Too hot? To some, this would seem like wishful thinking. After all, history is replete with examples of once hot asset classes that cooled down when Wall Street cast a spotlight on them. Add to this the fact that interest rates are likely to rise in the coming years and real estate is typically hurt in periods of soaring rates. But investors have to keep several things in mind, analysts say. First, long-term interest rates--including mortgage rates--are still near historic lows. And though "a rise in rates would certainly be bad for homebuilders," as it would have a negative impact on financing and demand for new construction, "a rise in rates, if it reflects a strengthening economy, could be good for hotels," says Russell Platt, chief investment officer for Dividend Capital Investments. "Frankly," says Platt, "it would be good for office buildings. And it would be good for retail properties," as more workers and more money mean greater need for office and retail space.
While this may not be an ideal time to step into homebuilder stocks, which rose about 45 percent a year over the past five years, there are still opportunities to be had, analysts say, among retailers that cater to the housing boom, namely Home Depot, the nation's second-largest retailer behind Wal-Mart, and Lowe's, the second-largest home improvement chain behind Home Depot.
This may seem risky, as research shows nearly a third of all money saved through mortgage refinancing is spent on home improvement. If mortgage rates rise and refinancing slows, this could affect these retailers' bottom lines. But analysts note that with the home sale flurry of the past three years, there is enough demand to keep sales of home improvement goods growing for some time. Stephanie Hoff, retail analyst for Edward Jones, believes Home Depot's sales will grow 10 percent over the next several years, while Lowe's could rise by 15 percent a year.
Another winner may be diversified real-estate operating companies, such as Forest City Enterprises. Michael Winer, manager of the Third Avenue Real Estate Value Fund, calls this Cleveland company, which began as a lumber firm but now owns, manages, and develops properties ranging from apartments to office buildings, "one of the biggest blue-chip companies nobody has ever heard of."
Forest City's strength lies in its diversity. A significant rise in rates could hurt housing starts, which in turn could affect Forest City's lumber operations. But at the same time, rising rates may lead to a jump in rentals, which could boost its apartment properties.
A simple way to find real-estate opportunities is to look for healthy pockets in the economy. The recent uptick in business travel is focusing attention on hotel companies like Hilton Hotels. "When you look at hotel companies since 9/11, many have done a great job in increasing occupancy, but they've achieved that with lower-paying group business," says Joseph Betlej, manager of the Ivy Real Estate Securities Fund. "Now that the economy is improving, they're replacing that with higher-paying business travelers."
Perhaps the most popular real-estate plays are real-estate investment trusts, or REIT s, which own and manage properties ranging from apartments to offices to industrial facilities. By law, REIT s must pass along to their shareholders 90 percent of their taxable income, which they generate from rental payments and asset sales. Jim Trowbridge, a portfolio manager for the AIM Real Estate fund, says regional mall-oriented REIT s look particularly attractive. Despite soft patches in the economy, "retail spending has really held up, and an improvement in the job picture should give consumers more confidence," he says.
One of Trowbridge's top holdings is Simon Property Group, which owns about a third of leading U.S. malls. Simon is extremely diversified, as no single retail tenant makes up more than 5 percent of the firm's rental base. Moreover, rents on newer leases are 20 percent higher than on expiring ones, according to Morningstar.
So far this year, around $6 billion of new money has gone into REIT mutual funds, which invest in REIT s of all types. Among the most consistent players over the past one, three, and five years have been AIM Real Estate, Cohen & Steers Realty Shares, and T. Rowe Price Real Estate. Some more-eclectic options are Security Capital U.S. Real Estate and Third Avenue Real Estate Value.
There is another reason why stock market investors may want to consider having a long-term position in real estate. Studies have shown that holding a small portion of your portfolio in REIT s helps reduce risk. For example, a portfolio of 50 percent stocks, 40 percent bonds, and 10 percent cash returned 10.9 percent a year on average between 1972 and 2003, according to an analysis by Ibbotson Associates. But had you shaved some of your stock and bond holdings and put the money into REIT s, you'd have done better. A 40 percent stock, 30 percent bond, 20 percent REIT, and 10 percent cash portfolio returned 11.5 percent a year during this stretch--and with lower volatility.
This story appears in the December 6, 2004 print edition of U.S. News & World Report.