REITs Prevail Over Naysayers

"REITs cannot continue to outperform the S&P 500 forever," Poutasse says. "They've now had six straight years of outperforming the S&P 500."

So what names will be good in 2006? Pire likes value creators that can develop properties to boost earnings rather than rely on a difficult acquisition environment. Examples include luxury apartment REITs like Avalon Bay (AVB) and Archstone-Smith(ASN). He also likes strong operating companies, such as Simon Property Group (SPG), the country's largest mall owner.

Lou Taylor, a Deutsche Bank analyst, believes apartment and mall stocks will perform best next year. In a recent research note, he says apartment companies could generate upside earnings surprises next year. He also likes Avalon Bay, and is favorable on BRE Properties (BRE), Camden Property Trust (CPT) and Equity Residential (EQR), along with Simon and General Growth Properties (GGP) in the mall sector.

Taylor believes REITs will post a total return of 8% to 12% next year, helped by low long-term interest rates, good fundamentals and another year of healthy mergers and acquisitions in the group.

Pire says one of the worst situations for REITs next year would be if corporate profits start roaring and the economy looks to be stronger than anticipated. This was the environment in 1999, when the NAREIT Equity REIT Index fell 4.6% on a total return basis.

If earnings growth looks average, REITs might perform in line with the broader equities, Pire says. And if economic growth looks weak, then yields on the 10-year note could drop further and REITs might outperform once again, he predicts.

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