If you’re wondering why your clients might benefit from real estate investment trust exposure in their portfolios, read on.

What Are REITs?

Real estate investment trusts usually hold and/or manage income-producing commercial real estate. Most REITs generate money from the rent they charge tenants. REITs come in many varieties:

  • Retail REITs account for around 24% of REIT investments, including shopping malls and freestanding retail. The financial health of the retail sector is a huge factor in determining the retail real estate outlook.
  • Residential REITs own or operate multi-family rental apartment buildings and manufactured housing. Low home affordability will push more people to rent. As a result, some of the largest residential REITs can be found in large urban centers.
  • Healthcare REITs invest in hospital, medical center, nursing facility and retirement home real estates. Since a majority of operators rely on fee reimbursements, health care funding will be a major factor in the outcome of these REITs.
  • Office REITs invest in office buildings and receive rental income on long-term leases. The state of the economy, unemployment rate, vacancy rates and capital are all deciding factors in this sub-sector.
  • Mortgage REITs account for around 10% of REIT investments. Fannie Mae and Freddie Mac are the most well known. Increase in interest rates could decreases mortgage REIT book values and future financing will be more expensive.

The Strength of REITs

REITs have historically been one of the best-performing asset classes around, with the FTSE NAREIT Equity REIT Index – a major gauge for the performance of the U.S. real estate market – averaging annual returns of 9.9% between 1990 and 2010, which is only second to mid-cap stocks. Real estate was the worst performing asset class of eight for just two out of the 20 years. Additionally, real estate yields have been historically better than fixed-income yields.

REITs were similarly strong in 2010, too; while the S&P 500 is up around 11%, REITs are up about 22%.

Analysts are calling a bottom in the commercial real estate market. As the U.S. economic recovery gains steam, more office space is being snapped up and the trend should continue through 2011. Vacancy rates are no longer rising and occupancy rates are higher than last year – a stabilizing or rising occupancy rate translates to greater cash flow for an REIT.

On top of that, many REITs saw their liquidity positions get stronger in recent months, and many issuers have accessed the capital markets to repay or refinance maturing debt.