Hidden opportunity

NEW YORK – Real estate investment trusts have taken a drubbing this year as some investors have grown concerned the real estate portfolios these companies hold are overvalued. But a drop in share prices of REITs could signal an opportunity for investors willing to look under the hood at what a company owns.

The adage about the importance of location in real estate is easily forgotten when times are good but can prove prescient when times are difficult. REITs, which generally pay out most of the income they generate through their investment properties through dividends, can invest in a variety of holdings from office buildings to malls to apartment buildings to self-storage facilities.

Given the variety, investors should remember that some investments will hold up better and even thrive while others wither.

“We are very selective in the markets that we’re invested in,” said David Siopack, co-portfolio manager of the Charles Schwab Global Real Estate Fund. He sees strength in commercial property markets in many big cities, particularly those in Asia, and looks for investments in those areas.

The fund uses metrics that scored big cities in Asia such as Singapore as most likely to show the best rental rate growth in the next 18 to 24 months, followed by Europe and then North America. He said the stronger locations generally show employment growth at or above the national average and have a finite amount of land for development.

REITs proved popular with investors hoping to ride surging prices during the real estate run-up of recent years. But as demand for real estate has cooled, many REITs have suffered. While REITs often invest in commercial property, those that make loans to residential and commercial marketplaces and at times invest in residential or commercial real estate debt have been hit.

Through the end of August, those REITs that invest in mortgages had fallen 45.4 percent for the year, according to the FTSE NAREIT Mortgage REIT index. Meanwhile, the bulk of REITs – equity REITs – are still down but not nearly as severely. Equity REITs invest in properties from industrial buildings to office building to malls and are off 7.5 percent for the year.

But for long-term investors, the declines could offer an opportunity to find sale prices on some REIT investments.

At the end of August, REITs were trading at about a 16 percent discount to the net asset value of their underlying real estate holdings, said Mike Kirby, director of research at Green Street Advisors, a research company that focuses on publicly traded real estate securities. On average, REITs generally trade at a 5 percent premium to their asset value.

“Historically REITs have done well after they traded at a discount,” he said. However, he said Wall Street has been right to show concern that in the real estate bonanza of recent years some REITs perhaps overpaid for some properties. He also noted tightening access to credit has made it more expensive to finance deals.