Five years ago, people were capitalizing on appreciating home and real estate assets. Then the financial crisis threw a wrench into those plans. But lately the worst appears to be over, as a variety of economic data show improvement.
However, investors still face bond yields stubbornly stuck at historical lows and interest rates that will likely be depressed until mid-2015. Given those stats, advisors are looking to other forms of investments that offer any slight chance of decent yields.
For that reason, real estate investment trusts have attracted their fair share of market interest, especially those in exchange-traded portfolios.
REITs In Action
Real estate investment trusts primarily generate revenue through rent collected on properties. The companies then pay out a hefty chunk of their net income to shareholders through dividends in order to qualify for federal tax breaks.
By pooling the assets, REITs reduce risk and provide greater diversification, since the capital is distributed through numerous properties. Investors trying to mimic such a strategy on their own would have to acquire multiple properties, which is rather time consuming and probably impractical.
REITs have recently benefited from a steady increase in office, retail and apartment rent prices and the recruitment of additional tenants. And the sector should continue to show strength, as long as job growth can support the higher rents and tenant demand.
A Caveat
The largest risk investors face is the REITs' ability (or inability) to collect rent. If the commercial side of the market weakens, over time it could weaken REIT yields to the point that shareholders no longer find them of value. The sector is especially sensitive to the economic environment-to changes in GDP, corporate profits and consumer confidence-and most of these factors hinge on the well-being of the job market.
That's important because economists don't expect job growth to quickly pick up anytime soon. The recovery in both U.S. and Europe remains uncertain, despite investors' optimism that governments could step in and help.
The sector might also be sensitive to increasing interest rates, which will inevitably rise from their current lows. As the rates increase, REITs could experience higher costs in capital, diminished cash flows and depressed asset values. Still, the Federal Reserve has decided to leave rates alone until 2015, so there is no immediate concern.
Gaining Exposure Through ETFs
REITs already give investors a diversified portfolio of real properties and trade like stocks. But investors can further diversify by tapping the market through exchange-traded funds, adding another layer of diversification. Some funds give investors exposure to a broad swath of various REIT sub-sectors while others focus on specific areas.