Nicholas Yulico

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REITs Defy Doomsayers Again

Nicholas Yulico

Real estate investment trusts have rallied over the past week as interest rate fears abated somewhat, but overall in August the NAREIT Composite Index still fell 4.25%.

However, for the year to date, the index has posted a total return of 7%, continuing a trend of beating the broader stock market, as institutional investors flock to the sector.

Thus far this year, the Russell 2000 his gained 3%, the S&P 500 is up 1.9%, the Nasdaq has fallen 1%, and the Dow Jones Industrial Average has lost 2.8%.

Mall REITs such as Simon Property Group (SPG Quote) and self-storage REITs such as Shurgard (SHU Quote) have been some of the best performers.

What's notable is that the resilience of REITs comes amid so much bearish sentiment on the group. Late last year and for most of this year, many analysts and pundits have been predicting doomsday for REITs, on the basis of interest rate fears and concerns over high valuations in the sector.

"I'm a little surprised that REITs are beating the broad market for six years in a row," says Keith Pauley, portfolio manager with LaSalle Investment Management. "What a lot of prognosticators looking for a downturn missed was that commercial real estate values have moved up dramatically."

Pauley, who himself raised some concern last year, adds that the stock prices of the REITs, "while they've had a big move, are supported by private-market values. ... I think we get worried when the stocks get way above the underlying value of their assets."

Right now, REITs on average are trading at a premium of 5% to their net asset value, which is lower than in recent years, according to Keven Lindemann, director of real estate research with SNL Financial.

One on hand, Lindemann says he's surprised at the REITs' performance and still believes stock prices will eventually come down. But on the other hand, considering the heavy fund flows into real estate mutual funds, Lindemann says the returns make sense.

Investor demand for REITs was strong in August, especially among institutional investors flocking to the four real estate ETFs.

Collectively, the iShares Cohen & Steers Realty Majors (ICF Quote), Dow Jones U.S. Real Estate Index (IYR Quote), streetTRACKS Wilshire REIT Fund (RWR Quote) and the Vanguard REIT Index Fund (VNQ Quote) saw $478 million of inflows in August, compared with an outflow of $374 million in July, according to TrimTabs Investment Research.

Meanwhile, regular mutual funds, which are where individual investors are more likely to put their money, saw just a $3 million inflow, roughly unchanged from July.

What this shows is that "individuals are not chasing prices and the professionals are," says Carl Wittnebert, director of fund flow research with TrimTabs.

After posting very strong second-quarter earnings, REITs' operating results are expected to remain solid. Fears about rising interest rates have been eased by the persistent low yield on the 10-year Treasury.

A bigger issue for REITs may be how the broader stock and bond markets perform. REIT stock prices may weaken if the overall markets improve and investors shift money out of the sector, Pauley says.