Investing in Real Estate without a Mortgage

By Nancy Zambell, BrokerAdviser.com | ICF | Feb 06, 2007 | comment

During the past few years of the "boom" cycle in real estate, many investors looked around and thought, "Boy, I wish I had the money to invest in some property." But most folks just don't have a few extra hundred thousand dollars lying around. And now that the market has slowed, the risks of investing in individual real estate properties have increased, making it somewhat treacherous for the average investor to jump in. 

However, both of those reasons - high investment dollars required, as well as the associated risks - have played an important part in the rapid expansion of the real estate investment trust (REIT) industry.

REITs were created in 1960 by an act of Congress to allow individual investors to participate in the ownership (and profits) of large-scale, income-producing real estate properties. Like mutual funds, they allow individual investors to "pool" their monies to invest, while sharing the risk of the investments. They are also excellent tools when used to diversify your portfolio as well as to allocate your assets. And, as with mutual funds, they are professionally managed. But REITs have one tremendous selling point not shared by most mutual funds -high dividend yields.

By law, REITs must return at least 90% of their taxable income to their shareholders, annually, which generally translates into very nice yields for the REIT investor, making these investment vehicles very attractive. According to the National Association of Real Estate Investment Trusts (NAREIT), the average dividend paid by REITs in 2006 was 3.69%.

But dividends tell just part of the story. For the past 10 years - as a whole - REITs have outperformed the broad market, gaining 14.5% (NAREIT index, including appreciation and dividends), compared to the S&P 500's 8.3% return. And for the past few years, REITs have been on a tear, returning an average 25.85% annually since 2004, and a whopping 34.35% last year!

Most real estate investment trusts (REIT) own - and usually - operate income-producing properties, including apartments, offices, hotels, shopping centers and warehouses. These are called equity REITs. Other types include mortgage REITs which finance real estate, and hybrid REITs, which own and finance properties.

Today, there are some 190 REITs registered with the Securities and Exchange Commission in the U.S., with assets of more than $400 billion.

As you can see from the following table, REITs tend to specialize in a particular type of real estate property.

Source: NAREIT

The market doomsayers have been busy for months predicting the end to the "real estate bubble" for months, now. And while the market has softened, the bell has not tolled. In fact, in December, the National Association of Realtors (NAR) reported that new single-family home sales rose 4.8%, the fourth monthly increase in the past five months. And...new home prices actually rose by 1.8% for the year. Also in December, the inventory of existing homes fell to a 6.8-months supply, the lowest in six months and closing in on what the NAR considers a balance market.

That's good news for the housing market and also for the REIT industry. Coupled with stable interest rates and a growing economy, the REIT sector should continue to shine.

In this particular environment, with condo prices still at relatively lofty heights, apartment REITs may attract those who can't afford to buy right now. The office and self-storage REITs should be helped along by a strengthening economy, while the mortgage REITs may find comfort with steady interest rates.

Now, before you run helter-skelter to buy any REIT with a high dividend, let me caution you - as always - to evaluate the REIT just as you would any potential investment.

• Is it currently trading at an undervalued level? Look at the REIT's P/E ratio, compared to its own historical trading level, as well as that of its peers.
• Debt should be reasonable, and the leverage should be used to grow the REIT's top and bottom lines.
• If the yield looks outrageously high in comparison to the industry, it may be an indication of too much risk.
• Revenues and earnings should be growing at a sustainable level.
• Find out the geographic regions in which the REIT invests. Check out housing prices, condo conversion rates and the current apartment rental market.

And if that's just too much trouble, perhaps you may want to invest in a REIT index fund. Here are a few for your consideration:

Source: NAREIT

If you would like further information regarding investing in REITs, here are a couple of web sites to get you started:

www.nareit.com

http://biz.yahoo.com/ic/mva/444.html

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