"Granted there are tax advantages to doing this,'' he says, "but, in essence, they are throwing more money into these investments." With losses mounting as high as $300,000 on the Florida homes, clients continue to pay up to $60,000 a year to cover the loans, he says. Out of a sense of obligation - and out of fear of ruining their credit - not one of them has handed keys to the bank or sought a short sale, Graziano says.
Parker sees the same determination. "I've actually been surprised how many clients regard it as a moral obligation,'' he says. "They say, 'It's not in my makeup to do anything other than pay back what I've borrowed.'"
Some underwater clients have found ways to breathe. Graziano says that one client bought a property for $220,000 at the top of the market, before the value dropped to $120,000. With a 7.5% interest-only loan and a balance of $168,000, the client was paying $1,800 a month on the loan, more than he could afford, Graziano says.
Help arrived in the mail. Although the client had unsuccessfully sought a loan modification once, Chase, which holds the property note, suddenly offered a 15-year, fully amortized loan at 4.65%. The client's new monthly payment dropped to $1,300, below the amount of the rental income, Graziano says. "He's still underwater for what he owes," Graziano says, "but at least if the market goes up and there's a crossover, there's an exit."
Obviously, his client is delighted. A Chase spokeswoman says the modification probably came through the federal Home Affordable Mortgage Program. The spokeswoman says the bank may solicit prospective participants for the program or a borrower can request it. She did not respond to questions asking why the bank initially turned the client away when he requested a modified loan. Graziano say he plans to tell other clients about the program.
Real estate appeals because of its bondlike income stream from rents and its stocklike appreciation over time. The original idea behind REITs was to help more Main Street investors access these qualities, plus liquidity, via large-scale, institutional real estate investments, says Rick Romano, a principal and REITs portfolio manager at Prudential Real Estate Investors. Prudential sells three REIT mutual funds. "You have some of the biggest trophy buildings across the globe owned by REITs," Romano says.
The maturation of the REIT market during the past 40 years has brought down returns, says Tim Courtney, chief investment officer for Exencial Wealth Advisors in Oklahoma City. "When the REIT market was still in its infancy," Courtney says, "there were no REIT indexes that you could go by, which is why there were some outsize returns."
A decade ago, it was difficult to invest in buckets of commodities, he says, and that lack of access drove up yields. In the 2000s, he says, REITs as a class produced a 12% annualized return, whereas the S&P 500 produced up to 2%.
He says he doesn't envision those returns in the near future. "We think that, going forward, it's unlikely there will be the kind of low, double-digit returns that we had with REITs because there's a lot of liquidity in the market," Courtney explains. "We would guess that REITs would probably generate returns somewhere between stocks and bonds. We feel that's where they should be risk/return-wise. It's a logical place for them to land, in terms of expected returns."
For now, Courtney believes that domestic REITs look fairly valued, a view that is largely shared by Romano, who adds that public REITs are trading near net asset value. "You are getting what you are paying for," Courtney says. "They are probably yielding a little less than 3.5% to 4% in rent pass-through as dividend and trading at about two times their book value. Those are probably fair prices. I wouldn't say they are really cheap or really expensive." REITs are required to distribute or "pass-through" 90% of their rents as dividend payments to be classified as REITs.
By contrast, Courtney thinks that international REITs may offer a better deal, with pass-through yields as much as 6%. The international real estate market has higher risks that can drive higher returns. "They look very attractive relative to the pricing," he says.
For his firm's clients, Courtney relies on index funds that buy pieces of all the approximately 200 REITs in the global market. He uses Dimensional Fund Advisors, an Austin, Texas-based firm started by University of Chicago academics.
Dimensional employs a passive approach, although the firm adjusts for momentum. If an investment starts to underperform or outperform, it may continue to do so for a few quarters. "The saying is, 'You don't want to catch a falling knife,'" Courtney says. The company charges 17 basis points for its U.S. funds and 40 to 50 basis points for its international funds.