Tony Thompson
September 14, 2010 marked the 50th anniversary of real estate investment trusts, or what is more commonly referred to as REITs, in the United States. Originally signed into law in 1961 by President Dwight D. Eisenhower, REITs buy, develop, and operate commercial properties such as office buildings, hotels, medical facilities, shopping centers and apartment buildings. REITs offer investors the opportunity to invest in income-producing hard assets and are typically more accessible to a much broader range of investors as compared to traditional real estate ownership. But why should investors consider REITs and other alternative investments, given the wide range of investment products available today?
Real estate and other hard assets have proven to be a valuable addition to an investment portfolio, often reducing volatility and increasing total returns. According to the NCREIF Property Index, which reflects returns on investment-grade, income-producing properties, the total average annual return from January 2000 to December 2009 was 7.3 percent. Conversely, during this same time period, the stock market was sitting in negative territory and the S&P 500 index produced an average annual return of -0.95 percent. Various studies, which have compiled data from the S&P 500, the Federal Reserve Database and NCREIF, have shown that adding allocations in real estate, ranging anywhere from 5 to 20 percent of an investment portfolio, can reduce overall portfolio volatility and increase overall returns.
REITs can be structured in one of three ways: as a publicly-traded REIT, a public non-traded REIT or a private non-traded REIT. Regardless of its structure, each REIT is required to follow the same strict guidelines as described by the Internal Revenue Code, which include paying 90 percent of its annual taxable income to shareholders, investing a minimum of 75 percent of its total assets in real estate and generating 75 percent or more of it gross income from investments in or mortgages of real property.
The traded and non-traded REIT structures each offer distinct advantages (or disadvantages) dependent upon an investor’s ultimate goals and objectives. Shares of publicly traded REITs are traded on a national exchange and offer complete liquidity to investors. While this may be advantageous for some, it also means that there is a direct correlation to the stock market, which can increase share price volatility. Non-traded REITs, on the other hand, are not traded on a national exchange and, therefore, do not fluctuate with the stock market. Investments in these types of REITs are more likely to mimic traditional real estate investments; however, liquidity is limited and may be subject to penalty if an investment is not held for the length of the program, which is typically 7 to 10 years.
Low interest rates have driven income-seeking investors to look at alternative investment opportunities, and REITs certainly have risen to fit the bill. Non-traded REIT dividends often range between 6 and 7 percent annually, while dividends paid by their publicly traded counterparts typically range from 2 to 4 percent. Given the 2.5 percent current dividend for the 10-year U.S. Treasury, it should come as no surprise that investors are seeking income from additional sources with real estate is now filling that void for many.
In light of the turbulence within the financial markets during the past 24 months, it may be hard to believe that REITs have been one of the best performing investments in the past year. The MSCI U.S. REIT index, which represents approximately 85 percent of U.S. publicly traded REITs, is up 37.4 percent, including dividends, compared to a 9 percent total return for the S&P 500.
2010 has brought with it an abundance of investment opportunities within the non-traded REIT space. Of the total 53 non-traded REITs reviewed by Blue Vault Partners in the second quarter 2010, 36 are currently raising capital and 17 are closed to new investments. Blue Vault Partners has also reported that total industry assets have grown to $67.3 billion as of June 30, 2010, up 3.9 percent from the previous quarter, and non-traded REITs sales totaled $2.2 billion in second quarter, as compared to $1.8 billion in first quarter. Additionally, the Fall 2010 Stanger Report, published by Robert A. Stanger & Co., reported that an additional six REITs were brought to the market in the third quarter with an additional nine offerings in the registration phase.
With this new wave of REIT offerings entering the marketplace, it will be crucial for investors to remember the basics of real estate investing when analyzing potential investment opportunities. The old adage “buy low, sell high” certainly comes into play here and investors should be wary of REITs that have been raising equity for several years. Many of the older REIT offerings acquired their assets during the height of the market, which may cause significant problems down the road when it is time to liquidate the portfolio. On the other hand, newer offerings should be able to acquire properties at significant discounts to the prices once seen at the height of the commercial real estate market and should be in a position to realize appreciation upon the sale of the portfolio.
— Tony Thompson is CEO of Thompson National Properties.