Invest in real estate without the mortgage

For people who want to invest in real estate without the responsibility of management but with the added benefits of sector diversity and liquidity, investments in REITs can be perfect.

An REIT is a company (corporation, trust or association) that invests most of its assets in real estate, and distributes out almost all of its income to investors. If it meets the required numbers, it does not pay federal income tax, so the investors avoid double taxation.

Wikipedia describes the purposes of REITs well:

“REITs own many types of commercial real estate, ranging from office and apartment buildings to warehouses, hospitals, shopping centers, hotels and even timberlands. Some REITs also engage in financing real estate. The REIT structure was designed to provide a real estate investment structure similar to the structure mutual funds provide for investment in stocks.”

The analogy to a mutual fund is a good one, and well describes one of the main advantages of a REIT: as an individual your financial resources limit the amount of real estate diversification you can control. But the REITs have a lot more resources and can diversify much better.

Another advantage of the REIT is sectoring. As explained above, most REITs specialize in a particular area of real estate. For example, Equity Residential (EQR) invests in apartment buildings, usually big ones. Others invest exclusively in commercial properties. Personally I think residential properties are much safer than commercial properties, and have more upside potential, so the fact that I can choose the area of my preference is a nice advantage to investing in REITs.

Health Care REITs have done well lately. An example is HCP. It primarily invests in properties serving the healthcare industry such as senior housing, life science, medical office, hospital and skilled nursing. The fund also invests in mezzanine loans and other debt instruments. It engages in acquisition, development, leasing, selling and managing of healthcare real estate and provides mortgage and other financing to healthcare providers.

It hit a new 52-week high recently at almost $49 a share. It was $38 a share just a few months ago. Its shares are up 6.6 percent this year. The company has a P/E ratio of 26.3, well above the S&P 500 P/E ratio of 17.7. For that reason many investors consider it now overpriced. Others think that its solid growth pattern shows a well-run company that will continue to experience growth in an important market. For me, the 4-percent-plus dividend yield is a very positive factor.

EQR is a company that I have invested in from time to time. Lately the stock seems to hover between $55 and $65, now toward the lower range at $56 (Feb. 26). It currently has a yield over 5 percent, which makes it very attractive. The company owns and operates apartment buildings all over the United States, which gives it good diversity. With a price-earnings ratio of over 20 some might think it overpriced, but with the continued rise in real estate prices I have always liked this company.

And finally, by way of another example, we come to what I consider the best sector of the REIT market: public storage. The company Public Storage itself has done well, but I have done extremely well with Sovereign Self Storage (SSS). The stock has gone up from $46 to $67 in the past year, driving the PE ratio to over 30 and yield down to just over 3 percent. So this is a company to buy during price dips, or to write naked puts against in an effort to acquire it below market price.

The important statistics to examine in a REIT are net asset value (NAV), funds from operations (FFO), and adjusted funds from operations (AFFO). Until the beginning of 2012, REITs were severely impacted by the recession, and there were some great buys available. That is less true today, but some have not fully recovered yet and offer good opportunities. Others have recovered but with the kind of yields available they still can be attractive investments for many investors.

Homework

Here is a list of REITs to research:

AvalonBay Communities (AVB)

Boston Properties (BXP)

Health Care REIT Inc. (HCN)

Host Hotels & Resorts (HST)

Kimco Realty Corporation (KIM)

Plum Creek Timber Company, Inc. (PCL)

Prologis (PLD)

Public Storage, Inc. (PSA)

American Tower Corp (AM)

Simon Property Group (SPG)

Ventas, Inc. (VTR)

Vornado Realty Trust (VNO)

AIMCO (AIV)

For information about Merv Hecht and more details on the strategies and stocks he writes about in this column, visit his website at DoubleYourYield.com.