At the moment, he doesn't believe REITs are "dramatically overpriced," but he doesn't view them as a bargain, either.
Those 28 percent annual returns in equity REITs (as calculated by the National Association of Real Estate Investment Trusts) have taken a toll. Many REITs, as a result, are trading at a 7-to-10 percent premium to their net asset value, or the value of their properties, he says.
The value of high-quality, institutional commercial properties (not mom-and-pop or low-quality buildings) sank 40 percent, on average, from their peak level of mid-2007 to their bottoms two years later. Since then, property values have climbed back about 30 percent, Leupold says.
But Leupold doesn't think prices will necessarily return to pre-crash levels, and realistically, will probably rise another 5 percent, less than the premium at which REITs are trading.Investing in Mutual Funds Despite the risks, it makes sense for investors to diversify their assets and have some investments in real estate. Leupold recommends individual investors "dollar-cost average" into the sector over an extended period of time, and invest in mutual funds instead of individual REITs -- which take time to research -- or exchange-traded funds like SPDRS Dow Jones REIT (RWR) or iShares FTSE NAREIT Residential Index Fund (REZ), which invest in a basket of publicly-traded REITs. "In the REIT sectors, actively-managed funds have tended to outperform the indices over extended period of times," Leupold says. "There are inefficiencies in the market that allow active managers to outperform." Last year, Forward Strategic Realty (KSRAX), JPMorgan US Real Estate (SUSIX), Morgan Stanley Real Estate (REFAX) and T. Rowe Price Real Estate (TRREX) were the best performing real estate funds, posting returns of 29 percent or more, according to Morningstar.com. These funds have minimum investment requirements ranging from $1,000 to $4,000, while ETFs don't require a minimum investment. Investor interest in REITs, in fact, may be one of the fundamental factors in their favor this coming year. Flows into REIT mutual funds and exchange-traded-funds are on the rise, and that should continue to boost returns, Guinee of Stifel Nicolaus says. The percentage of assets in Simon Property Group (SPG) generated by ETFs, for instance, has steadily grown, and was just less than 20 percent of the portfolio by the third quarter last year, according to Stifel Nicolaus. So, while yes, REITs may be trading at the high end of what analysts see as fair value, Guinee says: "Funds flows and good fundamentals outweigh possible full valuation." -- Written by Abby Schultz of CNBC
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