June 29, 2012
Written By Chloe Lutts Jensen
A lot of the most reliable income-generating investments don’t have much growth potential: they’re bonds with a fixed value, or companies that pass earnings on to shareholders instead of reinvesting them for growth. But there are plenty of exceptions.
One type of income investment that often also offers growth potential, particularly today, is the real estate investment trust, or REIT. REITs are special purpose entities, with special tax status, that own real estate and pass along most of the income from the real estate (rents) to shareholders. They can own everything from apartment buildings to malls, and many specialize in a certain type of property.
REITs have growth potential because they can increase rents if their properties become more desirable, and they can expand by acquiring more real estate. But today, many REITs also have an extra growth catalyst–a turbo booster, if you will.
Though the real estate market collapse of 2007 and 2008 didn’t hit rental properties as hard as it hit the residential ownership market, it still sent shockwaves through the entire real estate market. And four years later, many REITs (the ones that survived) still haven’t fully recovered. So in addition to their growth potential, these investments also have potential to appreciate based on value alone.
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For example, here’s a five-year chart of Apartment Investment and Management Company (AIV).
While AIV has recovered a stunning amount of value from its single-digit lows in early 2009 (over 400%!), it’s still more than 50% below its highs from early 2007.
Of course, AIV won’t necessarily return to levels it reached during the real estate bubble. But as Bob Howard, editor of Positive Patterns, wrote in the latest Dividend Digest, the REIT is making impressive recovery progress that hasn’t been fully acknowledged by investors. Here’s his recommendation:
“Apartment Investment and Management Company (AIV – yield 2.7%) announced in the most recent quarterly report that they will be accelerating their sales program (because they can–it’s a good market!). Properties scheduled to be sold in 2013-2015 will be sold this year. It should go well as it’s a seller’s market (unlike single-family housing). Also, the woods are thick with money wanting to buy apartments, as post-2008, the apartment business finds itself in a plum spot. …
“The relative strength here is impressive and gaining. I expect a lot of property sales, debt pay downs and quite possibly a stock buyback. I also look for AIV to bolster the dividend to a more generous level, once debt reductions are achieved. That will really help FFO (funds from operations, the REIT equivalent of cash flow) numbers. I would buy this up to $28 for a one-to-two-year trade.”–Bob Howard, Positive Patterns, June 2012
As Howard mentions, the recovery in the apartment rental market has been different from the very gradual recovery in the single-family housing market. To oversimplify, the woes of one have spelled opportunity for the other.
The markets served by other REITs are recovering too, each in their own way: commercial property, office space, storage space and more. Charts that look like AIV’s aren’t hard to find. In fact, if you were to imagine an average five-year chart of REITs (that have been in business since before 2008 and are still in business), it might look something like this:
That’s the Vanguard REIT ETF (VNQ), which owns parts of 104 REITs, of all varieties. And as Steven Lord, editor of Stephen Leeb’s Cash Cow, explained in the latest Dividend Digest, most of the ETF’s advance in the last three-and-half years has been a “bounce off the bottom.” There’s still a huge amount of growth and value that’s not reflected in VNQ’s share price. Here’s his argument:
“It should come as no surprise that real-estate investment trusts (REITs) are breaking out to new highs. Ten-year Treasury bond yields of only 1.95% and a promise from the U.S. Federal Reserve to keep rates in the cellar for at least the next year has made the dividend payouts from these trusts, always one of their most attractive characteristics, even more enticing to income-oriented investors. …
“However, it is equally important to note that the strong advance since last October is not due to extraordinary growth in the sector. Rather, it is much more a bounce off the bottom at this point. Important, too, is the value of real estate as an inflation hedge, something that should not be lost on anyone adding up the amount of money printed around the world over the past four years.
“Finally, the commercial and multi-family real estate spaces are not the same industries they were before the financial crisis: low interest rates, repaired balance sheets, fresh capital on the part of new investors seeking distressed valuations and improved operating metrics suggest REITs are on a better fundamental footing than at any time in the last decade.
“Our recommendation in this sector is Vanguard REIT ETF (VNQ – yield 3.4%), the largest and least-expensive domestic REIT ETF available. …
“The $12.5 billion portfolio is currently deployed across 104 positions allocated fairly evenly across the major subsectors of real estate. Retail REITs comprise 27% of the portfolio, residential 18%, office 16% and specialized–which includes storage, hotels, data centers and the like–28%. The top ten positions account for over 40% of assets, and include such behemoths as Simon Property Group, Equity Residential Properties, HCP and Ventas, so there is some concentration risk here. …
“VNQ is a great option for investors looking for exposure to the real-estate market recovery. It is a highly liquid ETF with stock-like returns, bond-beating income and low expenses. Ultimately, rising interest rates will present a problem for REITs, but that day is not yet here. VNQ is reiterated as a recommendation.”–Steven Lord, The Cash Cow, June 2012
And of course, in addition to the appreciation Lord foresees, you also get to collect regular dividends — the reason for REITs’ existence. Right now, VNQ yields about 3.4%. Not a bad stream of income to collect while you wait for larger gains.
Wishing you success in your investing and beyond,
Editor of Investment of the Week
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