Home sales may be slowing, but real-estate funds pay off

If you've tried to sell your house recently, you may have noticed that many of your neighbors have, too. You may notice, too, that the signs outside their houses say things like, "Price reduced," "Seller pays costs" or, "Come in and smell the air of desperation."

So, it may surprise you to know that while the residential market has been sluggish recently, real-estate funds have soared an average 35 percent the past 12 months. Will they sustain that pace? Not likely. But bold investors might be able to enjoy solid gains in real-estate stocks or a real-estate mutual fund.

Good diversifiers

Real-estate investment trusts, known as REITs, are in the business of buying and selling commercial real estate — apartments, shopping malls and even self-storage units. Some REITs also finance real estate. By law, REITs must distribute at least 90 percent of their taxable income to shareholders.

REITs have some attractive features. First, they're good diversifiers. The commercial real-estate market doesn't correlate very closely with the stock market. So, by investing in REITs, you own an asset that might rise when your stock holdings fall.

Investors also are attracted to REITs' towering dividend yields — towering, at least, compared with the typical stock's dividend yield. The average REIT yields 3.78 percent, according to the National Association of Real Estate Investment Trusts. By contrast, the average stock in the Standard & Poor's 500 index yields just 1.8 percent.

Let's start with the bad news. If the idea behind investing is to buy low and sell high, you have to question the wisdom of investing in an industry sector whose stocks have nearly doubled in three years.

And let's take another look at REIT yields. In January, the average REIT's yield fell to its lowest point since the REIT association began tracking them in 1971.

Why is that bad? A stock's dividend yield is its 12-month payout divided by its current price. Yields haven't declined because REITs have suddenly become miserly in their dividend payouts; rather, yields have fallen because prices have been driven up.

Room to grow

Joseph Betlej, manager of Ivy Real Estate Securities, thinks REITs still have room to grow. Betlej's reasoning:

The economy. The real estate that REITs invest in makes them sensitive to economic changes. In a robust economy — such as we have now — commercial real estate typically fares well. That's particularly true when unemployment is low. The jobless rate in January was 4.6 percent, according to the Bureau of Labor Statistics. Economists tend to see an unemployment rate below 5 percent as signifying a tight labor market.

New money. Hot returns attract new money; naturally, lots of money is flowing into REITs and real-estate funds. Investors poured an estimated $10 billion into those funds last year, says Lipper, the mutual-fund tracker. Assets in real-estate funds have swollen to $84.3 billion, up from $54.1 billion at the start of 2006.

New investors. Private equity funds, which pool money to buy companies, have been snapping up REITs. Three of the five largest REIT buyouts last year were by private equity firms, according to Mergermarket North America, which tracks mergers. Vornado Realty Trust has waged a bidding war with the Blackstone Group, a private equity firm, over a purchase of Equity Office Properties Trust, a larger REIT.

Ken Heebner of CGM Realty thinks some office REITs whose investments are concentrated in growing areas still are attractive. Ivy's Betlej says his largest holding is Simon Property Group, which focuses on shopping malls.

"We saw the regional mall companies become cheap in 2006 as people second-guessed the strength of the U.S. consumer," he says.

They guessed wrong: Consumer spending has been robust.