Don't Give Up on Real-Estate Funds

 

07 10월, 05:51online.wsj.com

After generally rising strongly over the past few years, the funds have fallen an average of about 12% since late May, when the Federal Reserve signaled it might soon scale back its bond-buying program and interest rates started to climb. (Although the Fed surprised the market in September by maintaining its monthly bond purchases, most see the move as only temporary.)

 

 But some professionals say that even though rising interest rates are negative for real-estate funds in the short term, investors shouldn't give up on the group yet.

 

 A Lesson From 2004

 

 "If rates are rising because the economy is improving, it's generally going to be positive for earnings growth" at real-estate businesses, says

 

 Paul Morgan

 

 , managing director at investment bank MLV & Co. Moreover, analysts say, when interest rates started to rise in 2004, real-estate securities and funds rebounded after an initial hiccup.

 

 At many real-estate funds and ETFs, the primary holdings are equity real-estate investment trusts, which are public companies that own properties such as office buildings, warehouses and shopping centers and make their money mostly in rents. REIT-heavy funds tend to be income-oriented because REITs have to pay out 90% of their taxable income in dividends to retain REIT status. The average dividend yield on equity REITs was 3.83% as of Sept. 30, according to the National Association of Real Estate Investment Trusts.

 

 The funds have suffered this year because rising rates make it costlier for REITs to borrow money for new developments or acquisitions.

 

 Some investors also have used REITs and REIT-heavy funds as alternatives to bond investments. With their big dividends, REITs "have had a lot of capital inflow just because of the interest in yield," says

 

 David Toti

 

 , REIT analyst at Cantor Fitzgerald. But when interest rates rise, that pushes down the prices of older, lower-yielding bonds—and can put similar price pressure on REITs.

 

 Over the first five months of 2013, investors pumped more than $10 billion of net new cash into real-estate funds and ETFs, according to research firm Morningstar Inc. Then in June, July and August, nearly $3.5 billion flowed out of these funds.

 

 Mitch Roschelle

 

 , leader of the U.S. real-estate advisory practice at PricewaterhouseCoopers LLC, says that these funds are "very sensitive" to investor behavior and that "when investors run for the hills and sell, prices fall…and that's exactly what investors did."

 

 But in fleeing these funds and REITs, investors may have lost sight of the big picture: The reason the Fed may wind down its bond-buying program is because the economy is slowly, but steadily, growing, which will ultimately help businesses that own real estate.

 

 Currently, "in many markets, there's not a mismatch between supply and demand," says

 

 Marc Halle

 

 , manager of the , up 4% this year through September. "As the economy gets better and we add more jobs, you can't produce more supply overnight…[so] we'll start to see landlords have pricing power." Higher retail sales and increased business confidence might push up demand and prices for many types of real estate.

 

 Still, Mr. Roschelle says that while the correction since May has made it "a tremendous buying opportunity" for investors with long-term horizons, it will take some time for cash flow at REITs to improve substantially because of higher rents.

 

 Fund Options

 

 For investors who are less interested in income,

 

 Colleen Chandler

 

 of investment-management firm VennWell LLC likes (and has clients currently invested in) , which focuses on growth and has holdings in land development, senior living, hotels, and data centers. The fund is up 16% this year through September. It has held up well because most of its holdings are in non-REIT real-estate-related companies that are less at risk from interest-rate spikes. only 10 to 13% of its assets are in REITs and it has a 1% yield, according to Baron. Ms. Chandler has used REIT funds in the past but says a growth-oriented real-estate approach is more appropriate in this investment environment.

 

 Brenda Wenning

 

 of Wenning Investments LLC in Newton, Mass., moved her clients out of real-estate funds in late May. She says she'll buy again once interest rates start to stabilize. She likes funds from manager

 

 Cohen & Steers

 

 Inc. for U.S. real estate, as well as fund.

 

 One big question mark is how much interest rates will move up and how swiftly. "The worst-case scenario is if we have a situation where rates go up very quickly, much faster than anybody anticipated," says Mr. Toti. That would raise REITs' cost of capital, reduce the profitability of new developments and acquisitions, and hurt real-estate demand.

 

 Mr. Lippman is a staff reporter for The Wall Street Journal in New York. Email him at daniel.lippman@wsj.com .