Real-estate stocks completed the year with gains that are twice as large as the broader stock market, the second year in a row that REITs outperformed the major stock indexes.
REITs, as measured by the Dow Jones All REIT index, were up 27% . While that is a smaller gain than last year, when REITs posted gains of 28.5%, the 2010 results handily beat the Dow Jones Industrial Averages, up 11% and Standard & Poor’s 500 index, up 12.86%.
The REIT rally was triggered by investors hunting for higher dividend yields. REIT dividend yields, while low compared to historical standards, are currently around 4% compared to 3.35% on Treasury bonds.
“The REIT yields are very attractive compared to anything else in the market,” said Brad Case, vice president of research and industry information for the National Association of Real Estate Investment Trusts. Since the beginning of the year, dozens of REITs have raised dividends, an about-face from last year when many REITs were cutting or suspending dividends.
Other investors were buying real-estate stocks based on economic fundamentals, basically a belief that commercial landlords will post stronger earnings from rising rents and occupancy in 2011.
Most of this year’s gains came early in the year after a number of REITs were able to successfully recapitalize their companies by selling large amounts of stock and bonds. The recapitalizations eased fears that a number of large companies would be forced into bankruptcy. By the fourth quarter, however, REITs failed to outperform the broader indexes as investors began to fret that stubbornly high unemployment might drag down the industry’s prospects and delay the time when landlords can raise rents. The DJ All REIT index was up 7.2% for the fourth quarter through Tuesday’s close, almost in a dead heat with the 7.3% return for the Dow Jones Industrial Average and modestly trailing a 10.28% gain for the S&P 500.
“The stocks are ahead of the fundamentals,” so the market is taking a well-deserved breather, said Jay Leupp, portfolio manager at Grubb & Ellis AGA Mutual Funds. He said that landlords should start raising rents and signing more tenants in the middle of next year resulting in higher earnings for REITs and between 10% and 15% annual returns for industry. “If the recovery is slower than expected, then REIT shares will likely sell off between 5% to 10%,” next year, Mr. Leupp said.
The extension of the Bush-era tax cuts and efforts by the Federal Reserve to stimulate the economy hasn’t helped REITs, in part because investors worry the measures could lead to higher interest rates next year.
Mike Kirby, director of research at Green Street Advisors, said this could adversely impact REITs because they are more interest-rate sensitive than traditional stocks. He noted that REITs function similarly to bonds because they have relatively high dividend yield and only moderate cash-flow growth.
Nearly all of the major REIT sectors ended up in the fourth quarter and and gains were across the board so far this year.
Hotel REITs posted the best performance of 19%. The lodging REITs were among the first of the REITs to take off since the market hit bottom in March 2009 because the industry is usually the first to benefit from an economic recovery.
Hotels “continue to have the wind at their backs,” said David Loeb, an analyst at R.W. Baird & Co. He said the resurgence of hotel stocks is being fueled by increased acquisition activity in the sector and signs that rates are rising in major markets like New York, Boston and San Francisco.
Regional malls were another top performer, continuing to benefit from stronger retail sales and expansion by large national discount retailers. Regional malls returned 11%.
Mr. Leupp said he expects mall landlords to raise rents 2% to 3% in 2011 as large retailers begin to expand again as consumer confidence returns.
“Retailers are focused less on surviving and more on growth,” he said, “to grow sales ( credit ad pruitt wsj)