By TIM PARADIS, AP Business Writer
Wed Feb 28, 2:33 PM ET
NEW YORK - If location is the golden rule of real estate, then many who invest in real estate mutual funds might at times feel as if they've stumbled upon a great deal in the fanciest building in town.
A big acquisition in the commercial real estate market has led some observers to speculate that demand will continue for companies that invest in real estate.
Known as real-estate investment trusts, or REITs, these companies have shown at times returns greater than 25 percent per year in recent years. REITs, which frequently invest in commercial real estate or larger residential projects such as apartment buildings, have dodged the financial wrecking ball that has left cracks in some parts of the housing market.
In early February, the Blackstone Group, a power hitter in the private equity world, acquired Equity Office Properties in a $23 billion buyout. The bidding war that erupted over the company, whose properties included choice commercial skyscrapers, spurred talk that other REITs might be snapped up by private equity companies looking for places to spend their vast sums of cash.
"More investors seem to find value every quarter and I would say it's probably too early to announce a top to the real estate market," said Jeff Tjornehoj, an analyst at Lipper Inc., which rates mutual funds.
"You're going to have some investors out there who believe the EOP buyout is not the last and they're probably willing to stretch their necks out a bit in the current environment because it seems so wide open for M&A activity," he said, in Wall Street parlance for merger and acquisition deals.
And even if the gains shown by REITs and the funds that invest in them cool in the coming years, as many analysts expect, the foundation could be adequate to support solid, though perhaps slower, growth.
"I think people are concerned that real estate has done so well that it's comparable to the tech bubble of the late '90s. I think this is a completely different animal," Tjornehoj said. "They make money," he said, offering up one contrast with many failed dot-coms. "They have a real residual value."
REITs are unique in that they skirt most income taxes by paying out nearly all of their income to shareholders through dividends.
This has often made REITs, which began to draw widespread attention in the 1990s, desirable for investors seeking income. But now investors appear to be clamoring as much for the real estate.
"At this point people are investing for appreciation, not income," Tjornehoj said.
Dionisio Meneses Jr., managing director at Charles Schwab, contends investors can benefit from those REITs that remain public and shouldn't simply look to the sector based on a notion that more real estate companies will be taken private.
While many REITs focus on commercial properties, some stick to shopping malls, for example, or apartment complexes, so it's important for investors to understand the types of REITs a fund might invest in.
"Certainly, the apartment REITs did very well last year and I think there is some concern that perhaps this side of the market is a bit overheated," Tjornehoj said.
"On the other hand, you have regional malls which have done very well and there aren't any new regional malls coming out this year so the opportunities seem to be there."
Differences in where the REITs put their money matter greatly. REITs that invest in manufactured homes appreciated 1.3 percent in January, while regional mall REITs surged 13 percent.
"There is the risk that they're going to be disappointed if they have invested in a narrowly focused REIT fund and didn't get the diversified portfolio that they probably should be after," Tjornehoj said.
Meneses predicts demand for REITs, which can allow smaller investors to have stakes in properties that would otherwise be too expensive, will continue to grow. The demand should help the funds that invest in them as well, he added.
"You need to have realistic expectations when you take into consideration what asset type you're talking about. The returns we've seen in the past won't be sustainable."
Tjornehoj likes the CGM Realty Fund for showing consistency amid changing conditions in the real estate market. It has shown five-year annualized return of 32.1 percent.
In general, investors should look at a fund's overall diversification, Tjornehoj said. He is impressed by ProFunds' Real Estate UltraSector ProFund. It has shown a five-year annualized return of 26.1 percent.
"They're pretty diversified as far as office properties go," he said, noting the fund had about a 3 percent stake in Equity Office Properties, which likely led to a tidy return following the buyout.
Whether the buyouts will continue is unknown, though some investors will likely be happy with returns from REITs in their portfolio, even if those returns are less than in recent years.