Diagnosing The Downturn

It seemed almost a sure bet.

In the past seven years, stock prices of publicly traded commercial real estate companies had soared more than 160 percent, far outpacing the broader market. Then, early this year, the shares stumbled, falling about 14 percent since early February.

"This drop is a big deal," said Arthur E. Oduma, a senior equity analyst at the research firm Morningstar. "It's not a good feeling for investors. They're used to double-digit returns."

Some investors are taking their profits and running, even though commercial real estate stocks are considered a staple of any well-balanced portfolio. These shares are typically a protection against inflation because investors collect handsome dividends that increase in high-inflation times as landlords raise rents. In addition, after real estate assets appreciate, investors get a share of the profit when the properties are sold.

But getting in now can be tricky. Turmoil in the softening housing market has muddled investor sentiment and cast a shadow over commercial real estate stocks.

For small investors, the most affordable and efficient way to gain exposure to commercial real estate is through real estate investment trusts, or REITs. Most of these companies own a mix of buildings. Some are specific to certain types of property, such as office buildings or shopping centers. Others focus on regions of the country. A few hold a diversified property portfolio. Through REITs, investors get a small piece of a variety of properties without the hassle or expense of being a landlord.

The fundamentals that drive these companies remain strong because the economy is growing, creating demand for hotels, offices, shopping centers and even industrial warehouses, especially in land-constrained urban hubs.

But some investors have confused the housing and commercial sectors, especially after trouble surfaced early this year in the market for subprime home mortgages, which cater to people with blemished credit and other risky borrowers.

"People think of real estate and clump everything together," said Dan Fasulo, a managing director at Real Capital Analytics, a research and consulting firm. "The commercial and residential are very distinct marketplaces."

Short-Term Focus

Consider the events that unfolded at Municipal Mortgage and Equity on Feb. 9, shortly after some subprime lenders announced a string of bad news. That day, shares of the Baltimore company tumbled 11 percent after the market opened. Investors -- jumpy about the home residential market -- saw the word "mortgage" in the company's name and bailed out.

The company's slide stopped only after the lender released a statement clarifying that it provided financing for developers of commercial property and rental housing -- not for the residential market. The shares then reversed course, recovering most of their losses in after-hours trading.

That kind of knee-jerk approach to real estate investing is shortsighted, said Keith Allaire, a managing director of Robert A. Stanger & Co., an investment banking firm specializing in real estate. Investors need to think of commercial real estate in the long term and stop worrying about its day-to-day performance, he said.