Real estate is for optimists, if the recent gains among real estate investment trusts is any indication.
As a group, U.S. REITs have risen 170 per cent from their lows in early 2009. Canadian REITs have done almost as well, rising more than 120 per cent. And neither of those returns factors in dividend payments.
The gains come as the economic recovery from the last financial crisis remains on shaky ground. U.S. unemployment is 9 per cent, consumer confidence is weak, the housing market is still a mess and the Federal Reserve has been busily downgrading expectations for U.S. economic growth over the next two years.
This is hardly the sort of backdrop you might expect for surging REITs. Yet, just as developers build today in the hopes of a better tomorrow, real estate investments also reflect better times ahead.
This makes them a relatively risky bet. However, we’re not talking about sunshine, lollypops and rainbows here: REITs aren’t exactly priced for perfection, and could do okay even if the recovery continues to plod along.
For one thing, most REITs remain well off their 2007 highs, despite their strong gains over the past 2½ years. Canadian REITs, as represented by the S&P/TSX REIT index, are still down 18 per cent from that high. U.S. REITS, as represented by the MSCI REIT index, are off 36 per cent.
The implication here is that prices have not factored in a full recovery, giving some breathing room for a few economic stumbles.
For another, REITs are in many ways ideal investments for sitting and waiting for better times to come. Their big attraction is the cash payouts they deliver, in the form of monthly or quarterly dividends.
Not all REITs came through the last financial crisis with their payouts intact, of course, but as a group they held up quite well.
That’s why investing in an exchange-traded fund that holds a basket of REITs might be the best approach for many investors because it spreads the risk among many names. If the economic recovery drifts, the dividends will keep flowing.
And finally, dividend yields for REITs are well above government bond yields right now, meaning that REIT investors are being compensated for taking on some risk.
This wasn’t always the case. About six months ago, the average yield on U.S. REITs was about equal to the yield on the 10-year U.S. Treasury bond. That’s rare, and it often signals trouble ahead. Sure enough, U.S. REITs fell about 20 per cent soon after.
Now U.S. REITs yield about 3.7 per cent, which is well above the 2-per-cent bond yield. Similarly, Canadian REITs yield about 5.6 per cent, which is well above the yield on the 10-year Government of Canada bond.
There is a lot of optimism built into REITs right now. But short of another bad economic downturn, they shouldn’t disappoint.