With Rates Down, Equity REITs Are Looking Up

Lately we've seen a string of Federal Reserve interest rate cuts designed largely to take some sting out of the subprime loan crisis and shore up the U.S. economy by making it (theoretically) easier to borrow (and shop). The distinct downside to these cuts for investors seeking dividend income has been a plunge in yields on all domestic financial instruments, including supposedly safe-haven bank certificates of deposit (CDs) and virtually all money market and short-term bond funds.

For investors who care to take on a little more risk, one alternative can offer comparatively high yields: equity (as distinct from mortgage) real estate investment trusts (REITs), companies that own and/or develop property, which I'll be talking about here and in coming days. I've always had kind of a soft spot for REITs largely because of their frequently-generous yields and partly because although they can let you down by either cutting their dividends, depreciating in share price, or both, they rarely let you down for very long. Eventually whatever made them drop — a nasty housing sector, a subprime crisis, falling rates — reverses itself and the REIT reverses with it.

The Dividend Portfolio currently holds two: one invests in commercial real estate structured finance in the U.S., the other in global residential, commercial, hotel and shopping center companies. Their share prices had a bad couple of seasons but have now both begun to rise. Their dividends have remained steady, although one company just reduced its last payout, which I was actually pleased to see since it helped preserve liquidity.

Average REIT yields in the U.S., Canada and Australia now significantly exceed average yields for bank CDs and U.S. Treasuries. Whether you're nearing retirement or just seeking some income for your portfolio, REITs are increasingly worth looking into. Still, it’s understandable why an investor would want to skip over them as a source of income: They're stocks, not bonds, and although they're attractive for their often high payouts, equity REITs as a class have a risk profile that looks more like small-cap value stocks than short-term Treasurys or CDs. On top of which they're susceptible to volatility in global securities; U.S. REITs dropped almost 20% last year. And it's still real estate. While the majority of REITs, especially U.S. ones, focus on commercial and multifamily rental real estate rather than single-family condos and homes, real estate overall has gotten a very bad rap lately. Nevertheless, these very factors are creating opportunity, about which more in an upcoming column.