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Commercial Real Estate May Boost Your Portfolio

The U.S. housing market remains in the doldrums, but that doesn’t mean there are no opportunities for investors in real estate. Commercial properties outperformed the general market during the first half of 2011 and seem likely to continue rewarding income-seeking investors through the rest of the year. International real estate also holds promise for the coming months and years.

Real estate investment trusts, known as REITs, provide a simple way to own real estate by purchasing a stake in an investment vehicle that owns or operates property. You get many of the benefits of real estate ownership while bearing far less risk than you’d take on if you purchased property on your own. REITs are bought and sold like stocks and must pay 90% of profits to shareholders as dividends.

In the United States, major REIT indexes advanced 10% or more during the first six months of 2011, compared with a 6% gain for the Standard & Poor’s 500 stock index. That’s not a new trend. The U.S. Real Estate Securities Index rose 28% in 2009 and another 28% in 2010, while U.S. stocks gained 26.5% in 2009 and 15% in 2010.

The residential real estate market continues to be plagued by an overabundance of properties on the market, but the commercial real estate market is only beginning to recover from very low levels of supply. According to Cohen & Steers, an asset manager specializing in real estate, new construction during the past three years was less than half its 25-year average, and the supply of commercial real estate is near a 20-year low. Now, with supplies beginning to rebound, Cohen & Steers predicts that U.S. REITs will boost dividends by 10% a year for the next five years.

Standard & Poor’s Ratings Services recently upgraded the North American REIT market from negative to stable. “Our baseline economic scenario suggests a continued recovery of the U.S. economy in 2011, including positive, albeit tepid, job formation,” S&P wrote. “Commercial real estate occupancy rates appear to have bottomed for all subsectors, including the lagging office, industrial, and non-mall retail subsectors.”

Among REIT sectors, timber REITs led in the first half with a total return of 16.7%, followed by selfstorage REITs at 15%, apartments at 14%, office buildings at 12.5%, industrial buildings at 11%, and retail properties at 10%. The regional malls segment led the retail category at 15.8%.

Globally, developing nations are fueling another type of real estate investment—the emerging markets REIT. As middle-class consumer markets grow in nations such as India and Brazil, these REITs are investing in companies that develop homes, retail complexes, and office and industrial buildings.

A recent study by Cohen & Steers forecasts growth of 10.7% in 2011 and 2012 for emerging markets real estate securities. The forecast for real estate securities within developed countries is for 6.5% growth.

“Emerging market real estate securities can access unique opportunities in global markets,” the report says. “In our opinion, high-growth expectations for these markets, coupled with the attractive risk/return profiles of this asset class, point to the potential benefits an allocation to emerging markets real estate securities can have on an investor’s overall portfolio.”

Cohen & Steers singled out Brazil as an appealing investment market for a number of reasons, including its similarity to the United States. Brazil has solid economic growth, a positive employment picture, lots of natural resources, good management teams, and a high level of commercial real estate activity, the report said.

When investing in REITs, it’s important to make sure they focus on investments with ample liquidity and on companies led by strong management teams. REIT managers must also assess each country’s economic outlook, risk profile, and government policies.

Investing in real estate requires due diligence whether you invest in the U.S. market or globally. The liquidity of real estate is more limited than that of equities, and commercial firms are highly dependent on positive cash flow. Investing globally poses even more challenges, because real estate markets in many countries are less efficient than in the United States and other developed nations.

While fully evaluating real estate investment opportunities is difficult for individual investors, we can work with you to diversify your portfolio by investing in domestic and global real estate development.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice

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