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REITs can boost yield returns, but buy cautiously

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"There's a big difference between commercial and residential property. Commercial property deals with leases and cash flow, while residential is largely priced according to supply and demand and emotions. There's no emotion in the valuation of commercial property."

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Carruthers advocates an allocation of 5 percent to 15 percent in most portfolios. Carruthers likes iShares' Cohen & Steers Realty Majors Index Fund ( ICF) an exchange-traded fund.

"A lot of these real estate holdings that are in an index product tend to be the retail and office REITs," he says. "If we have a weak economy or recession, they could struggle if vacancy becomes an issue. I think corporate earnings are fairly good right now. If they're stable or improving, the leases that are in place with these companies should be very sound.

"You don't see vacancies in good times. In long-term leases with good companies you have lease-ups built into the lease. It might not be every year but every two or three years."

Still, some experts think it might be a little late to jump on the train. John Coumarianos, a mutual fund analyst at Morningstar who specializes in real estate funds, urges caution.

"This bull run has lasted longer than anyone thought," Coumarianos says. "If you're long-term there may be a compelling reason to buy now. Real estate has shown a low correlation to stocks and bonds, so it's a good thing to have for asset diversification.

"But if you don't have a position, get in very slowly. Try to wait for dips, and stay at the low end of your allocation range. If you plan to allocate 5 percent to 10 percent of your portfolio to real estate, keep it closer to 5 percent."

There are two no-load mutual funds that Coumarianos recommends: T. Rowe Price Real Estate Fund (TRREX) and Third Avenue Real Estate Value Fund (TAREX).

Coumarianos points out that REIT index funds haven't performed as well as actively managed funds, but those who prefer an index fund may want to consider the Vanguard REIT Index (VGSIX).

Average annualized returns for real estate funds
Average annualized returns for real estate funds (%)

Source: Morningstar Inc.

Dorsey Farr, investment strategist and principal at French, Wolf & Farr Investment Advisors in Atlanta, says he's been caught off guard by the length of the rally but also believes it's a little late to jump into REITs.

"The average equity REIT is yielding a little below 4 percent, and you can get north of 5 percent with CDs. With REITs up more than 20 percent this year and the yield well below CDs and Treasury notes, they're not the place to go in search of yield, and you have the risk of the share price.

"In general I think it's reasonable that REITs provide exposure to real estate as an asset class and that's a hedge against inflation," Farr says. "But you have to be aware of the capital markets' valuations. Are these attractively priced today?

"The yield has fallen from almost 10 percent in 1999-2000 to now, a little below 4 percent. That suggests that valuations are far less compelling today than they were five or six years ago. I would approach them with some degree of caution, given the run they've experienced."

It's best to hold REIT shares in a tax-free or a tax-deferred retirement account, because, although there are some exceptions, in general most of a REIT dividend doesn't qualify for favorable treatment. The ordinary income portion of the dividend will be taxed at your individual tax rate.

Bankrate.com's corrections policy -- Posted: Nov. 10, 2006
 
 
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