Real estate may be cyclical, but having exposure to real estate — especially commercial real estate — in a portfolio as an alternative source of income can be beneficial. What’s the best way to evaluate whether it makes sense for a client? Andy Blocher, chief financial officer of Federal Realty Investment Trust, talked to Financial Planning about the risks and rewards of publicly traded REITS.
Q: Why would you say it makes sense to include REITs in a diversified portfolio?
A: There are a couple of key components with respect to REITs. The dividend is one. REITs are required to distribute 90% of taxable income as dividends to shareholders. Those dividends are a really nice hedge versus inflation. The dividend yield on REITs is higher than what you’re seeing in the S&P currently. I think that’s a principal advantage. Another point is that REITs provide a solid diversification play for equity holders. The moves of the REIT market haven’t been strongly correlated with the overall market. That diversification provides a benefit as well.
Q: What are the benefits of retail-focused REITs, in particular?
A: One of the ways people need to evaluate the REIT market should be based on the length of the leases. A hotel lease is a night or two. As a result, the ability of a hotel REIT to mark their leases to market very quickly provides value when rates are rising. Of course, the reverse is true; when the market goes bad, hotel REITs are also affected very quickly. For residential properties, lease terms are about a year. Retail leases are around five to seven years. With retail properties, there’s a good balance of what you have locked in place and what percentage of your properties you can mark to market.
If you happen to find a retail REIT that has good quality properties in good locations, that offers additional protection, as the REIT can probably raise rents even when the overall economy is suffering.
Q: What are some of the metrics advisors should consider when they’re evaluating REITs on behalf of clients?
A: Dividend history is a big deal. Federal Realty, for example, has increased its dividend every year for the past 44 years. In general, when trying to figure out the potential for dividend growth, look at management. What is the REIT’s management team doing to try to enhance value?
Savvy REIT investors also will look at a REIT’s earnings multiple, its FFO [funds from operations] multiple and net asset value. In addition, two key questions to ask are: relative to where shares are trading, what is the company doing to enhance future growth through core operations, redevelopment or acquisitions, and is the company in a good position to raise capital? The answers to those two questions will help you evaluate whether a subject REIT is a good potential investment.
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