REIT Rebound Doubles Investors' Pleasure

One of the best investments right now may be REITs, whose shares are rising and dividends are twice that of the S&P 500.

Author:: David MacDougall
Publish date:: Sep 28, 2009 1:00 AM EDT

BOSTON (TheStreet) -- The stock-market rally that's propelled the S&P 500 Index to a 14% gain in the past three months has featured few losers. Just nine of 154 industry groups have declined. Not only have real estate investment trusts been among the best performers, but their dividends are at least twice that of the benchmark index.

Three of the 20 top-performing industry groups in the past three months are REIT-related. Industrial REITs have surged 54%, diversified REITs have jumped 46% and office REITs are up 39%.

REITs, as the trusts are known, offer a highly liquid and dividend-paying way to gain exposure to the real-estate market without the headaches of property ownership. Companies pay out 90% of their taxable income as dividends. As a result, REITs tend to spit out very high dividends.

ProLogis

(PLD) - Get Report

Plum Creek Timber

(PCL)

and

Brookfield Properties

(BPO)

pay yields of more than 4.7%, compared with 2.4% for the S&P 500.

Sure, REITs were hammered hard in the economic downturn. The

MSCI US REIT Index

has fallen 56% over the past two years versus a 41% drop for the S&P 500. Those dark days look like they're over. New-home sales rose for the fifth straight month in August. Stronger-than-expected consumer confidence for September bodes well for spending, bolstering the economy, the real estate market included.

As the bottom fell out of the real-estate market, REIT dividends tumbled as rental income and mortgage payments became scarce and land-value write downs dotted the landscape. Investors who bought at the top, hoping for outsized current income, are now stuck with drastically reduced yields due to their elevated cost basis. Those who get in today may enjoy the opposite. Because of the rule about dividend payments, investors needn't worry about management deciding to withhold a larger portion of profits and slashing dividends.

REITs like

Simon Property Group

(SPG) - Get Report

Vornado Realty Trust

(VNO) - Get Report

and

Kimco Realty

(KIM) - Get Report

have had smaller dividends as revenue tumbled, and now their shares look fairly expensive. It's no coincidence that those companies have a big exposure to retail real estate. Vornado, for instance, is linked to the ill-fated Downtown Crossing project in Boston, which resembles 1942 Stalingrad after the project hit a financing snag. Retail locations have been hurt more than most due to a huge decline in consumer spending. As a result, office and residential REITs such as ProLogis and

AvalonBay Communities

(AVB) - Get Report

look like better bets to recover quickly.

Another restriction on REITs is a requirement that at least 75% of gross income be derived from rental income or mortgage interest. So there's little revenue diversity, exposing companies to a lot of risk. On the other hand, investors benefit by being able to directly wager on the fate of the real-estate market. Individual investors couldn't otherwise construct a portfolio of properties across America.

There may be a political snag. The Federal Reserve said last week it will slow the pace of its $1.45 trillion support of the housing market, and the popular $8,000 first-time homebuyer tax credit is coming to an end, changes that may push down property prices. Optimists, however, may see the Fed's reduced involvement as a signal that the real-estate market is beginning to stand on its own two feet.

-- Reported by David MacDougall in Boston.

Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.