Unrealistic assumptions, multiple layers of investors and obscene prices in the commercial real estate market are all part of the reason why the current housing bust is costlier and more complicated than previous ones, comment Mara Der Hovanesian and Dean Foust for BusinessWeek. Average housing prices have already plummeted 41% from the 2007 peak. (Long or short commercial real estate?)

In times past, developers would speed up production to cash in on a real estate bull market, but some defaulted on loans and lenders were stuck with what they financed. What makes this current bust novel is that the oversupply of money from our greedy and eager bank caused our current situation – you may have heard of mortgage-backed securities. “If the cash flow wasn’t there, you had to ignore it or find ways to create it,” remarks a banker at a large Wall Street firm.

Additionally, the wanton lending environment was ideally suited for confidence schemers and swindlers who were able to receive large loans. Loan officers during the credit boom were basically ignoring obvious problems that should have raised red flags.

More than $1.4 trillion in commercial real estate loans will be due between now and 2012. The potential losses or defaults may further dampen lending, and, consequently, impede economic growth. Some feel that if the sector can roll over this debt, REITs and ETFs may be fine. But if they can’t, it’s cause for concern.

Commercial real estate ETFs are trading above their trend lines right now, but watch them closely for any correction and have a stop loss. (How to follow trends).

For more information on the commercial real estate, visit our commercial real estate category. (The benefits of REITs).

• First Trust S&P REIT Index (NYSEArca: FRI): up 17.9% year-to-date

• Vanguard REIT Vipers (NYSEArca: VNQ): up 19.1% year-to-date

• SPDR Dow Jones REIT (NYSEArca: RWR): up 17.8% year-to-date

Max Chen contributed to this article.

Positive earnings from the tech sector lifted some spirits:

• Amazon (Nasdaq: AMZN) reported a 69% increase in its third-quarter profit, fueling hopes that the holiday season could be a good one for online retailers, reports Geoffrey A. Fowler for The Wall Street Journal.
• Microsoft (Nasdaq: MSFT) reported that cost-cutting helped deliver forecast-beating profits. The software giant also stated that consumer demand was strengthening.

Technology Select Sector SPDR (NYSEArca: XLK) is up 38.6% year-to-date; Microsoft is 9.9%

Existing home sales shot up 9.4% in September, handily beating estimates. It was also the largest monthly gain in 26 years, reports Alan Zibel for the Associated Press. Much of the increase is being attributed to homebuyers scrambling to purchase a home before the government’s tax credit for first-time homebuyers ends. SPDR Dow Jones REIT (NYSEArca: RWR) is up 17.7% year-to-date. (Visit our real estate category for more stories on the housing market.)

Federal Reserve Chairman Ben Bernanke urgedCongress this morning to push through financial reform. The central bank is also taking its own steps  to fix the wounded system, reports Michael S. Derby for The Wall Street Journal.

Meanwhile, the U.S. Treasury and Federal Reserve have unveiled new rules aimed at capping executive pay. While it doesn’t cap pay levels at any specific institution, it still has broad reach, reports Steven Sloan at Insurance Networking. The Fed that 28 large financial institutions to a review of their policies. (For more on the financial sector, visit our financial category).

The decline in the market should not dissuade any investor from allocating part of their portfolio to real estate, explains Julian Hince for Financial Times.

The benefits of real estate allocation include:

• A stable and steady income stream is possible
• Real estate has a low correlation to equity and fixed-income, giving clear diversification benefits
• Low price volatility is also a plus

Real estate investment trusts (REITs) have been looked at for their liquidity and as an alternative to direct property investment. REITs are publicly traded real estate companies that own, manage and sometimes finance real estate.

A REIT ETF will typically invest in a range of vehicles, offering investors the benefits of instant diversification through one single trade. Investors only need to make one transaction and track one price, but still gain exposure to the entire index at once. This makes them lower maintenance and easy to understand. They make it possible to have small investments in real estate.

For more stories about REITs, visit our REIT category. Among the many REIT ETFs available now:

• First Trust S&P REIT (NYSEArca: FRI): up 19.3% year-to-date
• Vanguard REIT Index ETF (NYSEArca: VNQ): up 20.1% year-to-date
• SPDR Dow Jones REIT (NYSEArca: RWR): up 18.9% year-to-date

Some good news for housing, as new home sales in the U.S. grew in August to the highest level in over one year. Builders cut pricing to compete with foreclosures and previously owned homes, reports Bob Willis for Bloomberg. If the worst housing slump since the Great Depression is finally turning, there are good ways to play the upward trend.

There is a so-called “big four” when it comes to domestic real estate or REIT, ETFs to pick from is you so desire the asset class for your portfolio. Don Dion for The Street says the following four are worth your consideration due to low fees, liquidity and diversification:

• iShares Dow Jones U.S. Real Estate (NYSEAcra: IYR)

The most popular ETF,with 24 million shares traded per day. Expense ratio is 0.48%, and there are $2.9 billion assets under management. IYR tracks the Dow Jones U.S. Real Estate Index, a float-adjusted, market-cap weighted index. Top 20 holdings are timber REITs.

• iShares Cohen & Steer Realty Majors (NYSEArca: ICF)

About 1 million shares per day are traded, and the expense ratio is 0.35%. Assets under management is at $1.7 billion. ICF follows the Cohen & Steers Realty Majors Index, takes into account management, portfolio quality and sector and geographic diversification. It rebalances quarterly such that no fund exceeds 8% of assets.

• Vanguard REIT (NYSEArca: VNQ)

VNQ has about 20 more holdings than most other REIT ETFs, and the sum of their allocations only came to 2.4% as of June 30. VNQ had $3.4 billion at the end of August and costs 0.15%. About 3 million shares per day are traded. This is a great buy-and-hold fund, but this ETF is not recommended for those who want up-to-date information on asset allocation. Since the fund does not re-balance quarterly as the others do, up-to-date information on holdings is not readily available. The low fees are unbeatable from a long term investor standpoint.

• SPDR Dow Jones REIT (NYSEArca: RWR)
  

RWR has $1.3 billion in assets and has an expense ratio of 0.25%. About 0.8 million shares trade per day, and  tracks the Dow Jones U.S. Select REIT Index, a float-adjusted, market cap-weighted index that rebalances quarterly. Compares the closest to IYR as far as holdings are concerned.

For more stories about real estate, visit our real estate category.

Assets: $1 billion

Objective: RWR seeks to track the Dow Jones U.S. Select REIT Index.

Holdings: RWR’s index is made up of companies whose charters are the equity ownership and operation of commercial real estate. Each REIT in the index is weighted by its float-adjusted market capitalization, according to State Street’s fact sheet on the fund. The top companies in the fund are Simon Property Group (NYSE: SPG) and Public Storage (NYSE: PSA).

What’s Good

• This ETF delivers diverse exposure to the real estate investment trust (REIT) market, holding a mix of apartments (15.2%), health care (14%), regional malls (13%), office space (12.4%) and more.
• This fund was down 41.5% in 2008, but since the market’s low on March 9, it has climbed more than 105%.
• RWR’s expense ratio is 0.25%.

The Latest News

• The IRS recently came out with new rules that would simplify commercial real estate loan refinancing in order to stem the tide of defaults
• These new rules would allow these loans to be refinanced without setting off tax penalties for investors
• Anton Troianovski for The Wall Street Journal reports that the recovery environment could reflect the 1990s, when many real-estate developers went public to avoid bankruptcy and helped turn real-estate investment trusts into a major force in the property market
• The sector has a heavy debt load, but if REITs can roll it over, the shares may not suffer
• REITs already have rallied about 90% from the 18-year low they hit in March as the drop-off in home prices and economic conditions has slowed, reports Donna Kardos Yesalavich for The Wall Street Journal

Once the commercial property market begins to recover, real estate investment trusts, or REITs, could be the front runner for the asset class. Anton Troianovski for The Wall Street Journal reports that the recovery environment could reflect the 1990s, when many real-estate developers went public to avoid bankruptcy and helped turn real-estate investment trusts into a major force in the property market.

REITs are in a good position to profit from the commercial property bust, but the equity deals that companies made have watered down shareholder stakes in ownership. But this left many REITs in a position to sidestep any loan defaults and benefit when the property market hits trouble.

Meanwhile, hotel shares, which are a staple in REIT investments, have outperformed the broader market. The stocks of hotel companies that are structured as real-estate investment trusts were up 11% during the past three weeks and 34% since the beginning of the year, reports the National Association of Real Estate Investment Trusts.

A.D. Pruitt for The Wall Street Journal reports that such gains far outpace the 6% year-to-date gain for all REITs and the 12% rise by the S&P 500 index. Investors are upbeat about hotel shares because improving credit conditions have allowed some hotel owners and operators to strengthen their balance sheets by refinancing debt or issuing additional stock. Some hotel owners are even walking away from some money pits and giving them to the lenders.

• First Trust S&P REIT Index Fund (FRI): up 10.1% year-to-date

• Dow Jones Wilshire REIT ETF (RWR): up 9.7% year-to-date; hotels are 6.3%

• iShares Cohen & Steers Realty Majors (ICF): up 6.1% year-to-date

For more stories about REITs, visit our REIT category.

REITs own a range of real estate, including office buildings, strip malls and apartment buildings. The sector has a heavy debt load, but if REITs can roll it over, the shares may not suffer. REITs already have rallied about 90% from the 18-year low they hit in March as the drop-off in home prices and economic conditions has slowed, reports Donna Kardos Yesalavich for The Wall Street Journal.

The sector at large saw a huge drop last fall, however, the stocks are anticipated to go nowhere but up if debt refinancings take place. As banks recover more, this is becoming increasingly likely.

Portfolios and managers alike are positive toward REIT shares and ETFs, as they are likely to avoid bankruptcy, and from a technical view, REITs look set to rise as much as 35% from current levels. There are market corrections and pullbacks to be wary of along the way.

• First Trust S&P REIT Index Fund (FRI): up 2.3% year-to-date

• DJ Wilshire REIT ETF (RWR): up 1.4% year-to-date

• iShares Cohen & Steers Realty Majors (ICF): down 0.2% year-to-date

For more stories about REITs, visit our REIT category.

Some investors have such a doom-and-gloom feeling about what lies ahead for commercial real estate that they’re considering whether shorting the sector is worth it. After all, storefronts lie vacant, vacancies are up in many major cities and office space sits empty.

Matt Krantz for USA Today explains that the commercial real estate sector is easy to short with an ETF. But here’s a word of caution for you: REITs pay out a vast majority of their earnings as periodic dividends. If a REIT ETF is paying out 9%, and many are right now, you will be required to cough up those 9% dividends to the party from whom you borrowed the shares while you are shorting the ETF. Ouch! Keep in mind, this is only when shorting a regular ETF.

There are also short ETFs available for this market, as well. If you still want in, bear in mind that leveraged and inverse ETFs need to be monitored closely, and shorting is not for everyone.

• ProShares UltraShort Real Estate (SRS): down 73.7% year-to-date

• Direxion Daily Real Estate Bear 3x (DRV): launched July 16

Larry Light for The Wall Street Journal reports that while the housing market is showing sings of bottoming, the commercial real estate market has a longer drop before a turnaround.

Among the issues facing the sector right now include:

• REITs face at least two years of crushing debt maturities
• Downward-sliding property values
• Low occupancy rates that continue to fall and earnings that are only weakening

Some, however, are bullish on REITs. There are analysts out there who feel that the sector has seen the worst, and 2010 will mark a period of improvement. Some pension funds are also jumping in. Cadillac Fairview Corp. acquired a 49% stake in a Queens mall last week. It’s a sign to some that more pension funds could be coming forward with money, says Anton Troianovski for The Wall Street Journal.

• SPDR Dow Jones REIT (RWR): up 6.9% year-to-date

• iShares FTSE NAREIT Industrial/Office Complex (FIO): up 4.4% year-to-date

For more stories about commercial real estate, visit our commercial real estate category.

Among the top-performing ETFs for the month include:

• DJ Wilshire REIT (RWR), up 32.4%
• iShares Dow Jones U.S. Home Construction (ITB), up 27.5%
• iShares MSCI Taiwan (EWT), up 26.6%
• Market Vectors Coal (KOL), up 28.9%
• First Trust Global Wind Energy (FAN), up 22%
• SPDR S&P Metals & Mining (XME), up 26.9%

The weakest ETFs for the month include:

• United States Natural Gas (UNG), down 13.8%
• Market Vectors Gold Miners (GDX), down 10.8%

In general, an investor who seeks a REIT is concerned with tax advantages, and a high yield. Jim Abbot of A Dash of Insight says that the REIT must return 90% of income to unit holders to avoid taxation at the trust level. Furthermore, the REIT provides smaller investors the opportunity to add real estate of various types to their portfolios without directly buying properties.

When the properties held within the trust depreciate substantially is when the biggest risk is incurred. Commercial real estate has taken the biggest hit since the economy has taken a beating. As of right now, the potential acquisitions are the reason REIT ETFs may have potential.

The leading REITs, such as Simon Property Group (SPG) or Public Storage (PSA), will acquire the senior secured debt, or the mortgage notes securing assets, of their weaker competitors at their current discounted prices and then simply wait for these companies to fall under their their own debt. Well-capitalized companies are in a winning position, and if the target company defaults, the acquirer is in the leading position to take over assets.

• SPDR Dow Jones REIT (RWR): down 11.9% year-to-date