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One of the sectors of the US stock market to be beaten down the most in 2008 was Real Estate Investment Trusts (REITs). Now, with the looming threat of inflation, this sector is worth a second look.
San Francisco real estate
REITs: A tricky business
The basic appeal of REITs in an inflationary environment is that many REITs own income producing real estate leveraged by long-term debt.
Some large REITs are highly diversified across geographic locations and are supported by competent, specialized property managers.
The basic rule of making out in inflation is to own real property and owe long term debt that you can safely service, as the value of money sinks.
Furthermore, many REITs specialize in particular segments of the market, such as apartments, shopping centers, office buildings, healthcare facilities, and industrial properties.
This allows them, over the years, to build up highly specific understanding of their particular market segments.
Significant risks
Many REITs, as recently as December 2008, still had average occupancy rates over 90% and were paying dividends that provided double digit market yields.
This is not to say that there are not signficant dangers in REIT investing:
- Some REITs are engaged in new construction and are dependent upon construction loan financing and renting out new properties. This is a dangerous area in times of recession and extremely tight money.
- Some REITs are engaged in commercial mortgage lending or investment in agency bonds. Holding debt, in general, in not attractive going into an inflationary environment.
- Some REITs have near term debt that requires refinancing. In order to be a good long term investment, it is necessary to make it through the short term.
- Some REITs may have dangerous conditions hidden in the terms of preferred shares, loan covenants, or derivative instruments. This means that competent, expert help is advisable before entering this market. There may be hidden pitfalls.
- Even with inflation, business cycles continue. Rents and occupancy will fluctuate. Skilled management and excellent properties are essential.
That said, the basic attraction of REITs as an potential hedge against inflation remains.
Buying properties at a discount
A particularly interesting aspect of the REIT market today is that these securities are often sold at a discount from net asset value.
Furthermore, there are closed-end funds that hold portfolios of REITS that sell at a discount of 20% or more of net asset value, based on the already discounted net asset values of the REITs in portfolio (NRO).
Finally, some firms that specialize in the analysis of REITS, like Green Street Advisors, have said that the book value of many properties in REITs is lower than current market values of similar properties in private sales.
Doing your own research
A salient feature of the REIT market, especially in the last two years, is that it definitely is not a prime example of the Efficient Market Hypothesis.
The stocks have been beaten down severely, often merely because of the word “real estate” in the company name.
This is a side show to the main stock market and good analysis is not free or readily available.
However, unlike gold, REITs offer investors the chance of both income and inflation protection based on ownership of real assets that have economic utility.
With inflation looming, if you have assets at risk, it is worthwhile to take the time and do your own research.
A disciplined approach
A disciplined way of doing your own research is to join Capital Market Wiki as a founding editor.
There you’ll find templates and guidelines for serious factual research, plus you’ll have the advantage of others looking over your work, picking out errors and adding things you might have missed.
Furthermore, you can do this research anonymously, without risking your real world reputation.
Finally, the research you do may help you find consulting assignments or even a job, using the wiki’s semantic opportunity network.
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