REITs

Their spectacular run means a correction is more likely than not, and investors are advised to take profits while they can, writes MoneyShow's Howard R. Gold, also of The Independent Agenda.

With interest rates so low on almost everything, investors have been desperately searching for yield.

That’s why they’re still scooping up bond funds, despite all the warnings. It’s why they’re still piling into dividend-paying stocks, high-yield bonds, master limited partnerships, business development companies—anything that yields more than 2%.

And it’s why they have still been buying real estate investment trusts (REITs), despite the huge run REITs have had since the bear market lows of 2009.

During that time, REIT returns easily topped major equity indices like the Dow Jones Industrial Average. They have outperformed the S&P 500 for 11 of the last 16 quarters. Their yields are way down from their peaks. And increasingly they have moved in tandem with stocks, rather than being a counterweight to equities in investors’ portfolios.

REITs are companies that own a portfolio of commercial properties, such as office buildings, shopping centers, and apartment complexes. They get tax breaks if they pay out 90% of their income each year to shareholders. That’s where the higher yields come from.

But in a piece published earlier this year, Joe Davis, head of Vanguard’s Investment Strategy Group, warned investors not to use REIT yields as a substitute for the interest on bonds.

“REITs tend to correlate with the broader equity market, not with bonds,” he wrote in his article, “REITs: A Word of Caution.

“If you substitute REITs for bonds in order to generate greater income, the final result is a more aggressive and more stock-heavy strategic asset allocation.” Translation: buying REITs may give you more stock exposure than you want.

“[Stocks and bonds] are two different asset classes and they have different risk characteristics,” Davis told me in an interview. “My point is that [REITs] are a component of the equity market.”

In fact, he told me that “during volatile markets, REITs can [move] more because of their smaller size.” Case in point: the financial crisis, when the FTSE/NAREIT Equity REIT index plunged 70% from October 2007 to March 2009, while US stocks plummeted 57%.

Of course, REITs outperformed stocks easily in the years before the crisis and in the four years since, when the FTSE NAREIT index has soared by over 300%, more than doubling the S&P 500’s gains of 141%.

During that time, REITs’ yields have fallen from over 11% in February 2009 to below 4% now. That’s still a lot better than the yields on ten-year Treasuries and corporate bonds—but remember, they’re not bonds.

NEXT: Making the Case for REITs