REITs Prevail Over Naysayers

This time last year, many experts were saying that the remarkable REIT bull run was sure to end in 2005. Hopefully you didn't listen to them.

For the sixth year in a row, REITs are set to outperform the broader stock market. Low long-term interest rates, improving commercial real estate fundamentals and a lackluster stock market have kept investors' cash within the sector.

Year to date, the NAREIT Equity REIT Index -- which includes all publicly traded REITs except mortgage REITs -- is up 11.7% on a total return basis. Compare that to the S&P 500, which is up 5.8% on a total return basis.

Although much of the gloom forecasts at the end of last year came from sell-side analysts, many buy-side investors also were turning cautious on the group. A similar scenario is playing out this year.

One veteran expecting more modest returns for 2005 was Timothy Pire, portfolio manager of the real estate securities group at Heitman, which has $13 billion of real estate assets and stocks under management for institutional clients.

Pire expected REITs to post total returns of between zero and 10% this year. He admits he missed the ball on interest rates. "I thought rates would be higher, and with rates being higher that some of the yield-driven capital would flow someplace else," he says.

But interest rates remained low this year, which helped money stay within the REIT sector. Going forward, rates are expected to inch up but not rise too much unless inflation picks up.

Doug Poutasse, chief investment strategist with AEW Capital Management, which manages $20.6 billion of institutional capital, has an outlook for REITs in 2006 that is similar to his forecast at the end of last year. He expects REITs to post single-digit returns in 2006 -- with all returns essentially coming from the dividend, with price appreciation being flat. He admits that his more bearish views for 2005 were wrong but feels the outperformance has to end at some point.