Look for REITs Back on Earth

Real estate funds will be going for a three-peat in 2005, but investors expecting another year of overall market leadership will probably be disappointed.

REIT funds trumped all other Morningstar fund categories in 2004, returning a gaudy 30%. And that was coming off an even stronger 2003 when they were up 37%.

Back-to-back 30%-plus gains may not be unprecedented, but they don't come around too often, especially in an asset class like REITs, which are more income- than growth-based. Despite the past two profitable years, most analysts and fund managers expect the era of outsized gains to end in 2005 with REIT returns finishing in the 9% to 11% range. They also say results could be far worse if interest rates spike for the wrong reasons, like a crippled U.S. currency as opposed to steady economic growth.

"REIT performance depends on the economy now," says Samuel Lieber, portfolio manager for the $250 million (EUEYX)Alpine U.S. Real Estate Equity fund. "We've gone beyond balancing out the inefficiencies of the late 1990s."

REIT shares were ignored during the tech bubble as investors chased after growth-oriented companies more interested in reinvesting their cash than paying out dividends. Following the bubble's collapse, however, investors about-faced and poured their investment dollars into steady, income-producing assets like REITs.

That cash spigot has yet to be turned off despite the run-up in prices, says Lieber, who expects REITs to return 10% in the coming year, half of that coming from dividends. According to Lieber, huge institutional dollars have been committed and not deployed into REITs and the "weight of that money should sustain prices and valuations in the coming year."

Furthermore, that stream of institutional money is bearing down on a relatively narrow group of stocks, which only serves to support REIT share prices. According to the National Association of Real Estate Investment Trusts, or NAREIT, the entire market cap for the roughly 150 publicly traded equity REITs is around $260 billion, or, in other words, 10% less than the market cap for Dow component Microsoft(MSFT).