|Even Within Small-Caps, Smaller Is Better |
The IJR has consistently outperformed the more popular IWM
|Small-Caps Get Expensive |
Higher P/E and falling profits are a bad combination
REITS: How Low Can Yields Go?Real estate investment trusts, or REITs, have been one of the best-performing asset classes in recent years, far outperforming the stock market. Now we realize that predictions of REITs' imminent downfall abound, but there's another reason it may be time to take the money and run: Yields are not only at historic lows, they may be even lower than you think! According to the National Association of Real Estate Investment Trusts, the dividend yield on the average REIT has fallen to 4.4%, its lowest level in 35 years of recorded history. But what about the iShares Dow Jones U.S. Real Estate Index Fund ( IYR), a popular REIT ETF? Using a weighted average of the consensus estimates of 2006 dividends for the individual REITs which comprise IYR, the fund's yield is about 4.1%. However, that figure likely includes not just dividends paid from operating cash flow but also so-called return of capital to shareholders. This can happen, for example, when a REIT sells a property at a capital gain, and then distributes these gains to shareholders. It's been happening a lot in recent years. In fact, such returns of capital have grown from nothing in 2000 to 27% of total distributions paid by IYR in 2005. Cash is always welcome in our pocket, regardless of its origin. But the point is that return of capital, driven by capital gains, may not persist in a cooling real estate market and should not be relied upon. Further, expenses of the fund are deducted from dividends received by the fund before they are paid to shareholders. That's true of all funds, but where yield is the primary focus it's particularly important. Finally, many investors do not realize that dividend income from REITs does not qualify for the lower tax rates enacted by Congress in 2003. The result is a substantial reduction in the income that investors in IYR can expect to receive going forward. Assuming about 25% of 2006 estimated dividends are really returns of capital (similar to 2005), then IYR's true, dependable yield would decline from 4.1% to 3.1%. From this, subtract the fund's 48 basis points of expenses, and after fees you're looking at about 2.6% yield. Finally, if you own IYR in a taxable account, its after-tax yield is only about 1.7% assuming a 35% tax rate.
|The Incredibly Shrinking Yield |
REIT dividends may be even lower than they first appear