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January 31, 2008 at 07:00 PM
Several financial advisors contacted by Income Planning say that for those who use real estate investment trusts (REITs) to fund regular income, there is a real risk of diminished income.
Three of 4 financial advisors contacted say that sub-prime woes may take a dent out of regularly anticipated REIT cash flows. One says his clients will not suffer, but this is because of how the REIT he uses for clients is invested.
“Yes, it sure does matter what sort of REIT a person owns these days, and yes, I would say that most of them, whether they deserve it or not, have been swept up in the current trouble surrounding financial services and real estate businesses,” says Michael Martin, chief investment officer with Financial Advantage, Inc., Columbia, Md.
As an advisor, there are a few actions that can be taken to protect a client, according to Martin. One step is to diversify, he says. Diversifying sources of income “is of top importance,” he says, because of “the humbling reality that we are always unsure about the future! Diversifying is our admission of a certain amount of ignorance!”
Once the REIT market returns, he says, the choice of REIT is important. Martin says that when the market was better, he selected a REIT that owns and lends against buildings that are occupied under long-term lease agreements–usually 10 years or more–and are contracted by investment grade tenants. Consequently, Martin continues, there is greater confidence in the “sustainability of a dividend.”
As an asset class, REITs have become overvalued and their yields are not what is needed to meet clients’ income needs, he adds. And, there is a “good possibility” that “some kinds of commercial real estate may join the ranks of residential investments with some bad debt troubles.”
Don Martin, a certified financial planner with Mayflower Capital, Los Altos, Calif., also says he believes that the current drop in the residential real estate market can affect REIT income.
Although there may be no impact initially, Martin reasons, in the long term, if owners cannot sell their homes, they may be forced to rent them out. Or, if people foreclose on a property, then a “new, more solvent investor” may rent out the property after picking it up at a fire sale price.
If the economy goes full throttle into a recession, he adds, the loss of REIT income could become worse. He cites the 1990 recession and its impact on the market in southern California. For those who bought at the top of the market, it took the entire decade to break even, and even longer if factoring in the time value of money and realtors’ fees, he says.
Don Martin also raises concerns that lending “errors” in the commercial real estate mortgage market have yet to surface. These will put downward pressure on income from commercial REITs, he predicts.
