The Tycoon Report

REITS: An Oasis In the Real Estate Desert!

Another dismal report is out this morning on residential Real Estate. CNBC quotes Standard and Poors as saying that the U.S. subprime housing crisis will not peak until 2009 and total defaults could reach $150 billion. As a result, the U.S. economy will see lower growth and will be easily surpassed by the economies of other countries throughout the world.

But the news isn't all doom and gloom for Real Estate investments. While we wait for prices to stop falling (which may take awhile), there is one way to invest in real estate that has produced excellent returns over many years, and especially in recent weeks.

I am referring to Real Estate Investment Trusts, or REITS for short. According to the National Association of Real Estate Investment Trusts, "A Real Estate Investment Trust is a company that owns, and in most cases, operates income-producing real estate. Some REITs finance real estate. To be a REIT, a company must distribute at least 90% of its taxable income to shareholders annually in the form of dividends."

There are different kinds of REITS. Some invest in commercial properties, such as shopping centers, strip malls, storage facilities, or offices. Others invest in residential properties, such as apartment buildings, Assisted Living Facilities, or nursing homes.

REITS actually outperformed the DOW and S&P 500 from 1975 to 2005, with a compounded annual total return of 13.8%. But 2007 began as a tough year for REITS, as problems in the sub prime market spilled over to, and negatively impacted the stock prices of most REITS.

Between February and August, many of the REITS were down as much as 35%. That's more than a correction, that's one heck of a bear market! The sell off was not totally unexpected, as many of the REIT stocks were at overbought levels, and their dividend yields were very low by historical standards. When dividends are too low, REITS are not that attractive, because it is the dividend that tends to boost their total returns, rather than huge growth or earnings. It is rare to see a REIT stock beat or miss earnings estimates by more than a penny or two.

However, since August, REIT stocks have staged a dramatic turn around, largely due to the FED cuts, but also because all the bad sub prime news has now been factored into their prices. Furthermore, dividend yields have once more returned to incredibly attractive levels.

For example, lets look at two REITS, one residential and the other commercially oriented.

The first REIT is Liberty Property Trust (LRY), which owns and leases over 700 industrial and commercial properties in both the USA and the UK.

The second is Senior Housing Properties Trust(SNH), which invests in senior citizen apartment buildings, nursing homes, and Assisted Living Facilities for the elderly in 200 properties across 30 states.

I wish to be upfront and disclose that I own both of these stocks, and that a family member works for one of these companies. However, I am not trying to tout these particular companies, but rather just discussing them because I am most familiar with their stocks.

Having fallen from a closing high of 53.91 on February 7th, to a low of 34.27 on August 15th, LRY has now bounced back to close at 42.81 yesterday. That is roughly a 25% gain, not including dividend payments. With a .62 quarterly ($2.48 annual) dividend per share, at its peak February price, LRY was yielding only 4.6%, while at the August low, the yield had climbed to 7.2%. The current dividend yield is 5.8%, and the quarterly dividend has recently been increased to .625 ($2.50 annual) per share.

When the dividend fell to 4.6%, there were many alternatives which could produce similar income, but with less risk (T-bills, money markets, CD's). Therefore the stock became less attractive, and sold off substantially. But when dividend yields rise to levels that exceed other types of investments, they once again begin to attract investors. Therefore, the REITS have to increase their dividends to shareholders as the stock prices rise.

Senior Housing Properties Trust (SNH), has an annual dividend of $1.36 per share. At its February peak of 26.75, the dividend yield had fallen to 5%. That's not too shoddy, but Wall Street was in a mood to slash prices on anything related to real estate, and so SNH sold off. By the time it hit a closing low of 17.16 on August 1st, the dividend yield had risen to just a shade under 8%! Since the basic fundamentals of the company hadn't changed, this was a great opportunity to buy shares with an extremely attractive yield.

Since the August low, SNH has now risen to 22.31, a gain of 30%, not even counting the dividend! The current yield is still a very attractive 6%.

Thus, while the news on the Real Estate front has been absolutely dismal in the past 10 weeks, the performance of the REITS has been excellent, and REITS have become the "oasis" to the current real estate desert.

Thus, I would recommend that investors allocate a small amount of REIT stocks or mutual funds to their overall portfolio. They are not usually as volatile as they have been this year, and will provide you with steady growth of capital and income over time. For more information, and a good list of REITS, go to yahoo finance and do a finance search on REITS.