Carefully Chosen REITs May Offer Investors a Buying Opportunity

By Tim Paradis
Associated Press
Sunday, September 9, 2007

NEW YORK -- Real estate investment trusts have taken a drubbing this year as some investors have grown concerned that the real estate portfolios these companies hold are overvalued. But a drop in REIT share prices could signal an opportunity for investors willing to look under the hood.

The adage about the importance of location in real estate is easily forgotten when times are good but can prove prescient when times are difficult. REITs, which generally pay out most of the income they generate from their investment properties through dividends, can invest in a variety of holdings, from office buildings to malls to apartment buildings to self-storage facilities.

Given the variety, investors should remember that some investments will hold up better and even thrive while others wither.

"We are very selective in the markets that we're invested in," said David Siopack, co-portfolio manager of the Charles Schwab Global Real Estate Fund, which invests in REITs and other real estate vehicles. He sees strength in commercial property markets in many big cities, particularly those in Asia, and looks for investments in those areas.

The fund uses metrics that scored big Asian cities such as Singapore as most likely to show high rental rate growth in the next 18 to 24 months, followed by cities in Europe and then North America. He said the stronger locations generally show employment growth at or above the national average and have a finite amount of land for development, keeping prices high.

REITs proved popular with investors hoping to ride surging prices during the real estate run-up of recent years. But as demand for real estate has cooled, many REITs have suffered. While REITs often invest in commercial property, those that make loans to residential and commercial marketplaces and at times invest in real estate debt have been hit.

Through the end of August, those REITs that invest in mortgages had fallen 45.4 percent for the year, according to the FTSE NAREIT Mortgage REITs index. Meanwhile, the bulk of REITs, those in equity, are still down but not nearly as severely. Equity REITs invest in properties including industrial buildings, office building and malls and are off 7.5 percent for the year.

For long-term investors, however, the declines could offer an opportunity to find sale prices on some REIT investments. At the end of August, REITs were trading at about a 16 percent discount to the net asset value of their underlying real estate holdings, said Mike Kirby, director of research at Green Street Advisors, a research company that focuses on publicly traded real estate securities. On average, REITs trade at a 5 percent premium to their asset value.

"Historically, REITs have done well after they traded at a discount," he said.

Kirby said, however, that Wall Street has been right to show concern that in the real estate bonanza of recent years some REITs perhaps overpaid for some properties. He also noted that tightening access to credit has made it more expensive to finance deals.

"Clearly, the cost to obtain a commercial mortgage has risen pretty substantially this year," he said. "We're seeing very, very few handshakes on real estate deals in the last month."

Kirby said it is far from clear that the public market has been too hard on REITs. "They've been beaten down and probably about rightly so," he said. "But unless you're really bearish, it's not a bad time to buy REITs."

Kirby noted, for example, that REITs that invest in malls generally hold higher-end properties, whose shoppers are less likely to be affected by a slowing economy. And with mortgage defaults on the rise, REITs that invest in apartment complexes could benefit from an increase in renters, he said.

Siopack takes a long view.

"Real estate has seen sharp valuation increases in the last couple of years, but we believe that that's to a large extent warranted because real estate fundamentals are strong and continue to be strong," Siopack said.

Schwab started the fund, which has assets of about $283 million, at the end of May with the contention that global real estate share prices have been hit too hard and do not adequately reflect demand in many markets.

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