Want to buy a shopping center, store or mall? You could rent out the property and get more income than from a bank or money market.
Of course, unless you’re part of the 1 percent, owning retail property outright is out of the question. But ordinary investors can buy into retail properties the same way they buy into Alphabet (ticker: GOOG), Ford Motor Co. (F) or General Electric Co. (GE) — by owning shares.
In this case, the vehicle is a real estate investment trust that works much like a mutual fund. There are REITs that own everything from resorts to hospitals to self-storage units, and one subset specializes in retail business space such as malls, shopping centers and free-standing stores.
The economy may be ‘just right’ for REITs. Is this a good time for a retail REIT, given the so-so economy, the rise of online shopping and an environment of increasing interest rates?
“The biggest short-term headwind is rising interest rates and the effect they have on real estate valuations and economic activity,” says Shawn Howton, a finance professor at Villanova University.
When borrowing becomes more expensive, those who buy retail properties have less to spend, undermining property values. And if shoppers have less to spend because of higher credit card rates, stores will make less, some will go under and fewer new ones will come along to replace them, hurting REIT rental income.
At least, that’s one theory. In fact, interest rates remain very low and are not expected to rise substantially any time soon. Joseph Pavnica, head of real estate at investment manager AMP Capital, says the pace of economic growth has actually created “Goldilocks” conditions for retail REITs — an economic window that is not so hot as to cause inflation, but not so cold as to cause a recession.
The slow recovery discouraged retail construction, leaving the supply of retail space tight, while the economy has recently been strong enough to keep demand for that space fairly high, he says.
“The overall prospects for the mall and shopping center retail REITs have been, and continue to remain, quite healthy, especially for the higher-quality portfolio owners that we gravitate toward,” Pavnica says.
How do REITs work? Like other investment pools, REITs collect money from investors, but in this case use it to buy real estate instead of stocks or bonds. Regulations shelter REIT profits from taxes at the corporate level, but in exchange require that at least 90 percent of income be passed on to shareholders. With retail REITs, that’s mostly from rents charged to store tenants, though there also can be profits when properties are sold.
These earnings, passed to shareholders as dividends, are taxable at various rates depending on whether the source is rent, or long- or short-term capital gains. Unless, of course, you hold the REIT in a tax-favored account, like an IRA.
There are about 30 retail REITs with nearly $200 billion of shares outstanding, according to the National Association of Real Estate Investment Trusts. Overall, there are 167 REITs worth more than $900 billion.
Through November, retail REITs returned 1.53 percent, a bit of a disappointment after 2014’s 27.6 percent [the return combines share-price changes and dividends].
While REITs produce long-term gains if the properties they own grow in value, most investors are drawn by the dividends. Those have averaged around 3.7 percent this year, while the 10-year U.S. Treasury note yields about 2.2 percent and bank savings pay nearly nothing.
Among the top retail REIT performers this year are Retail Opportunity Investments Corp. (ROIC), a West Coast shopping center REIT returning about 9 percent; Urban Edge Properties (UE), a new REIT which owns shopping centers in the Northeast and has returned about 15 percent over the past three months; and Agree Realty Corp. (ADC), a nationwide owner of properties leased to national tenants like Lowe’s Companies (LOW) and McDonald’s Corp. (MCD), returning nearly 10 percent.
Dividend income aside, REITs also offer diversification, since real estate often does not rise and fall in tandem with stocks or bonds.
“REITs are an important part of a mixed-asset portfolio and have been shown to increase returns while lowering risk when added to a portfolio of stocks and bonds,” Howton says. “They provide income, some inflation protection and diversification through low — though increasing — correlations with stocks and bonds, and professional real estate management.”
Like many experts, he suggests that between 5 percent and 20 percent of a long-term portfolio be devoted to REITs, with about 25 percent of that portion put into retail REITs.
The outlook for REITs. The retail industry, of course, has plenty of risks, and even if the economy is healthy an individual mall or shopping center may fail for any number of reasons. But these need not be insurmountable problems for a REIT that picks its properties carefully.
“The fundamental outlook for the retail REITs is quite positive, despite the generally tepid retail sales environment and negative headlines that would suggest malls and physical stores are toast,” says Benjamin Yang, senior vice president of Adelante Capital Management, a REIT and real estate investment advisor in Oakland, California.
“It’s important to note that the retail REITs have gone through a portfolio culling process since the Great Recession, buying higher-quality properties while selling assets that are not growing or, worse, slowly dying,” he says.
“The negatives with respect to investing in retail REITs are predominantly perception issues as opposed to reality,” Pavnica says. “Tired headlines such as “The Death of the Mall” date back to the 1980s and seem to get rehashed every so often.”
Despite the rise of online shopping, consumers still go to brick-and-mortar stores, even if just to check out or pick up products they’ve seen online, he says. Though store closings get lots of attention and feed the perception that retail is in trouble, short supply and healthy demand often allow landlords to quickly replace lost tenants, often at higher rents.
Still, even if a REIT’s holdings do well, the value of the REIT shares may not, says Josh Klimkiewicz, chief operating officer of Acquire Real Estate, a crowdfunding business for real estate investment.
“You are not actually investing your money in real estate investments,” he says, noting that market sentiment can cause REIT shares to trade above or below the value of the fund’s assets. That doesn’t happen with an ordinary mutual fund.
Morningstar, the Chicago-based market data and analysis firm, says that in recent years REITs have been 41 percent more volatile than stocks in the Standard & Poor’s 500 index and 4.5 times more volatile than the broad U.S. bond market. REITs should therefore not be seen as an alternative to low-risk holdings, such as bonds or bank savings.
An investor considering retail REITs needs to look carefully at the properties in its portfolio, and many investors don’t want to dig that hard. One option is to leave the picking and choosing to the pros and invest in retail REITs though a mutual fund or exchange-traded fund, Howton says. Vanguard REIT Index ETF (VNQ) is the largest REIT exchange-traded fund, yielding nearly 4 percent. There also are many mutual funds investing in REITs.
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How to Invest in Real Estate Through REITs originally appeared on usnews.com
