By Al Root

Real estate investment trusts have started to outperform the market. That's a good sign, giving investors a chance to add some "opportunistic diversification" to their portfolios -- and get paid along the way.

Through August, the iShares Core U.S. REIT (ticker: USRT) and the SPDR Dow Jones REIT $(RWR)$ exchange-traded funds have returned more than 20% over the past 12 months. That's approaching the gains of the S&P 500 index, and is dramatically better than the single-digit five-year returns for both ETFs.

Jason Browne, president of Texas-based investment advisory firm Alexis Investment Partners, believes it's the start of a trend. "The REIT story is all about opportunistic diversification," he says. That is, "diversification with an opportunity to add value, as opposed to just seeking to dampen volatility."

Normally, investors are focused on the latter. REITs always offer relatively attractive income -- right now, the iShares REIT ETF yields about 3.1% and the SPDR REIT ETF yields about 3.4% -- and it's that yield that helps tamp down volatility in a portfolio. But Browne also found that when REITs start to beat the market, the outperformance lasts a year or two.

REIT outperformance is partly related to expectations for falling interest rates, which make their payouts look relatively attractive compared with other potential yield options. The real estate business is also starting to improve. BFR Research CEO Brian Rauscher looks at earnings-estimate revisions coming from Wall Street to identify inflections that can lead to stock price outperformance. REITs revisions are getting "less bad," he says, which could signal the start of a turn.

REITs can also offer a good hedge against a potential reacceleration of inflation, says Research Affiliates founder Rob Arnott, because rents tend to track overall price levels. He prefers the Pimco RealEstateRealReturn Strategy mutual fund (PRRSX), which adds another dose of inflation protection by owning Treasury inflation-protected securities, or TIPS, as well as REITs. It yields about 2.8%.

For investors interested in individual stocks, BofA Securities analyst Jeffrey Spector recommends sticking with quality REITs, which should hold up better as the U.S. economy slows down. He is particularly fond of housing and apartment REITs, including single-family rental specialist American Homes 4 Rent and Mid-America Apartment Communities, which owns properties in the Sunbelt. Those REITs yield about 2.6% and 3.6%, respectively.

Ten REITs in the S&P 500 with strong support from Wall Street are: gaming REIT VICI Properties, which owns the buildings that house casinos in Las Vegas and elsewhere; data-center owner Equinix; grocery-anchored retail property owner Regency Centers; document-management company Iron Mountain; senior-living centers Ventas and Welltower; wireless-communications infrastructure REITs SBA Communications and American Tower; industrial REIT Prologis; and Host Hotels & Resorts.

The average Buy-rating ratio for those 10 stocks is about 75%, well above the 55% average for REITs in the S&P 500.

For the 10, funds from operations -- a REIT term comparable to net income for a typical corporation -- is almost four times interest expenses, similar to the average interest coverage for all REITs in the S&P 500. But they yield an average of about 3.3%, a point higher than the 2.3% for the average dividend-paying stock in the index.

Sometimes, you can have your yield and enjoy the upside, too. B

Write to Al Root at allen.root@dowjones.com

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(END) Dow Jones Newswires

September 11, 2024 01:30 ET (05:30 GMT)

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