The Right REITs for
Yield, Safety and Growth

By Marc Charles

A real estate investment trust or REIT is a company, usually traded publicly, that manages a portfolio of real estate. One of the great advantages of investing in REITs is that they are subject to special tax requirements which require that they distribute at least 90% of their taxable income to shareholders.

In this article, I’ll tell you about some REITs you may wish to avoid, as well as those that should offer a very nice return in the years ahead.

Most publicly traded REITs focus on commercial real estate, which means that they are less susceptible to the booms and busts of the housing cycle. Residential REITs had a negative return of more than 25% in 2005, but they have yielded a 14% return (on average) in 2006, according to the National Association of Real Estate Investment Trusts (NAREIT).

Although residential REITs have enjoyed a nice return in 2006, this sector has its share of problems, as you well know. In my opinion, the housing slowdown will accelerate in the 12-24 months ahead, particularly in the larger metropolitan areas like San Francisco, Boston, Miami, Denver, Los Angeles and Chicago.

Accordingly, you should avoid investing in REITs that have more than 20% of their property portfolio in housing. I’ve identified six of them below.

• Annaly Mortgage Management (NLY)
• Luminent Mortgage Capital (LUM)
• Thornburg Mortgage Asset Corporation (TMA)
• Aames Investment Corporation (AIC)
• HomeBanc Corporation (HMB)
• Arbor Realty Trust (ABR)

Hospitality REITs are also in for hard times. Hospitality REITs usually focus on hotel, resort, retirement, and restaurant properties. Most areas of the country are experiencing a glut of hotel development and although most retirement communities in warmer climates are full, older retirement communities and those in colder climates are not faring so well.

I would also avoid REITs in the commercial space that that are heavily focused on conventional office space and warehouses. For the most part, these sectors are up this year, but I expect they will also feel the pinch of the downturn in residential real estate, albeit with a lag.

However, there are two sectors of commercial REITs that should outperform residential and conventional commercial REITs in the coming years: Self storage and healthcare (especially prime medical office space and nursing homes).

Self storage and healthcare REITs may not produce double digit gains over the next 12-24 months. But this sector should provide single digit returns with a sleep-at-night level of safety.

Self storage REITs generally perform consistently, regardless of economic conditions. They are one of the few REITs that do. In bad times people look to self storage companies because of moving, loss of jobs, bankruptcy, etc. In good times, people use them simply for the cheap extra storage space. The revenue generated by self storage fees is typically quite consistent.

The best managed self storage REITs focus on prime locations and properties – and therefore the real estate also tends to appreciate slightly better than residential housing or conventional office buildings.

Healthcare or Medical REITs also perform well in good times and bad. When was the last time you saw a vacant medical office building with “For Sale” signs plastered on it?

Healthcare REITs that focus on research facilities and properties adjacent to teaching hospitals or universities perform even better.

Here are some REITs in the self storage and medical sectors you may wish to consider:

• U-Store-It Trust (YSI)
• Public Storage, Inc. (PSA)
• Sovran Self Storage, Inc. (SSS)
• BioMed Realty Trust (BMR)
• Omega Healthcare Investors, Inc. (OHI)
• Windrose Medical Properties Trust (WRS)

REITs in sectors that will be affected either directly or indirectly by the residential housing slowdown should be avoided. But looking on the bright side, those that focus on self storage and healthcare should provide a safe and profitable refuge for your investment dollars.

Good Investing,

Marc