September 14, 2010

What Can We Expect for Real Estate?

REITs have outpaced the stock market over just about every conceivable historical period

REITs have been putting the rest of the stock market to shame, returning 17.8% year to date (through September 10) while the S&P 500 languished at 0.90%. That's not just a 2010 phenomenon, either. In fact, REITs have outpaced the stock market over just about every conceivable historical period: 12 months, three years, 5, 10, 15, 20, 25, 30, 35, and since inception of the benchmark index for U.S. REITs in January 1972.

Over the last 10 years, REIT returns averaged 10.2% annually while the S&P 500 was stuck at -0.8%. What explains such consistent outperformance?

Publicly traded REITs have a big advantage that most other stocks don't. REITs own only about one-tenth of the income-producing property in the country, which means that most real estate is in the hands of other investors--especially private equity real estate funds--that, frankly, have proven themselves less capable in terms of their investment decisions or their property management, and probably both.

Good investors buy low, sell high. During the real estate bubble in 2006-2007, REITs sold a net $86 billion of property at peak values. But somebody had to take the losing side of those deals, and largely it was private equity real estate funds, which bought a net $49 billion at the peak.

Now the real estate market is about at its trough, and REITs are the most active buyers--while private equity real estate funds are mostly idle. Why? Because publicly traded REITs have access to capital--both equity and debt--on good terms, while private equity funds don't.

Now private equity real estate funds are in deep trouble: over the next few years funds face soaring debt maturities, and many are likely to default on their debts. Opportunistic funds admit to having lost 56% during 2008-2009, but not all distress has been reported yet.

That means two things. First, investors are anticipating that REIT earnings will grow dramatically over the next several years--partly from their ability to acquire solid assets (including some from distressed sellers), and partly from better operating fundamentals once the economy improves. Second, as long as REITs own a minority of the commercial property in this country, they'll be able to continue taking advantage of the poor decisions made by private equity real estate funds.

That's the gift that just won't stop giving, and it's an advantage the rest of the stock market can't match.

For more background on this issue, see the recent CNBC web and videocoverage.

Brad Case is vice president, research & industry information, for NAREIT, the National Association of Real Estate Investment Trusts. NAREIT is the worldwide representative voice for REITs and publicly traded real estate companies with an interest in U.S. real estate and capital markets. NAREIT's members are REITs and other businesses throughout the world that own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study, and service those businesses..

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