Cash in Hand
Keep Real Estate Investments Real
REIT stocks are under pressure from interest rates and slack rents, but investors in real properties could still make money, if they have the expertise.
By Jeffrey R. Kosnett, Senior Editor, Kiplinger's Personal Finance
August 10, 2005
If it sounds like this and other columns overdo real estate, it's because the field is never boring.
I talk with financial planners on a regular basis, and it's common for them to be active direct property investors as well as advocates of REITs for income and diversification.
But with REIT stock prices under pressure from higher interest rates and evidence that office and apartment rents and occupancy rates will be stable but not grow much, the questions become
- Should you skip this area entirely now?
- If you want to invest, what is the smartest way to do so?
A look at REITS
Last week, the typical property-owning REIT fell by 5%, and then lost another 3% on Monday before a bit of a bounce on Tuesday. Because the average property-owning REIT's dividend yield is down to 4.5%, much of which is taxable at ordinary income rates, REIT shareholders just lost something like two years of income.
Now, I know, real estate trusts are still up for the year despite all the talk of a bubble or Alan Greenspan's "froth."
Truly, though, it's starting to look silly to buy REITs.
If you have some shares you've owned a long time and can rationally compare the current dividend rate to your original share price, you're fine. You've also made a lot of money.
But I would not want to plunge too deeply into an AMB Property (AMB), which yields 4.1%, or Vornado (VNO) at 3.6%, or even apartment chain Avalon Bay (AVB) at 4.4%, is awfully risky. These are perfectly good companies. The stocks are just too expensive. I'd wait for a 5% yield, which I'd bet would come as the result of lower stock prices and not sharply higher dividends.
You could screen for REITs that yield 6% or 7%, but the good ones that appeared so under priced earlier in the year are no longer cheap. Retail and industrial REITs would be the best targets, though, again, the risk there is that rents will decline (as well as occupancy rates) and dividends won't grow.
Get real about property
So, then, why are so many investment advisers still enthused about real estate? Put it this way: They aren't talking about real estate securities, but real property. They are willing to put up their own money, sometimes get their hands dirty, and shop patiently for opportunities, as opposed to buying stocks or partnership units.
A young man told me that he and an acquaintance who is a carpenter bought a ruined house in a fancy Midwestern suburb for $120,000 and spent $100,000 to rescue it. He says they are about to sell it for $375,000 on a street where that's a bargain, not a bubble price.
An older adviser who used to be a commercial real estate lender for Wachovia tells me he buys 20-acre plots of land about a year ahead of the urban sprawl (the chain homebuilders lock up all the bigger tracts) and subdivides it into three- and four-acre pieces. He likens this to potato chips, where a tiny bag costs 79 cents and a huge one $2.99. Even after his financing and holding costs and taxes, he cleans up.
These are deals that take money, time and expertise. They also don't fit a pattern or follow a script. It's a lot easier to buy REITs than to invest for real in real estate, but I predict the smart people who do the latter can deal with the cycle better than Wall Street.
I like REITs as much as anyone, but everything has its price.
