a place for reits

8/6/2019 A Place for Reits

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iome financial planners

take a strategic approach toS REITs while o thers use themtactically, with some seekingthe best of both worlds . - ^

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For non-traded RE ITs, where investors may learn aboutthe sponsor's plans up front, Bass prefers low to moderateleverage. "That's particularly true in a low-interest-rateenvironment," he says. "I'm not a fan of all-cash deals."Using leverage (and having to pay m ortgage interest) m ayreduce cash flow to investors but might ultimately pay offif the properties are sold at a profit.When asked why he keeps a significant allocationto REITs, Bass responds that high yields, historicperformance and portfolio diversification all play a role."However,"he says, "diversification is the m ost imp ortantfactor. We've seen studies about the use of REITs andtheir impact on returns and portfolio volatility."

As mentioned, REITs'lack of correlation to U.S. stockshurt in the late-1990s bull market. However, REITs hadpositive returns in 2000 to2002, while stocks crashed,and REITs continued to lead stocks for the next severalyears. Large R E IT losses in 2007 to 2008 were surround -ed by banne r years, before and after, leading to results thatbolstered overall portfolio returns for the last decade.TACTICAL PLAYS

Of course not every advisor views REITs as anall-weather allocation. "As far as REITs' role in ourportfolios, we do not have a strategic allocation," saysJack Chee, senior research analyst at Litman/GregoryAsset Management in Larkspur, Calif "We gain REITexposure via a tactical allocation when we are confidentthat the asset class offers attractive returns relative tocom peting asset classes under the econom ic scenarios weconsider possible or likely."

Currently, Chee lacks such confidence. "We believethat fundamentals have improved," he says. "We areseeing rents increase, occupancies stabilize or improveand dividends increase. RE ITs' access to capital is strong.At the same time, a lack of supply from new c onstruetionis helping to fuel demand from tenants. However, REITvaluations appear to be pricing in m any ot these positives.In our view, REIT valuations are rich by just about everymeasure we look at."Che e adds th at his firm doesn't accept the "conventionalwisdom" that REITs can be expected to have a lowcorrelation with equities. "The REIT declines we sawin 2008 runcounter to thegenerally perceived beliefthat REITs are low beta [less volatile] and not highly

correlated w ith th e broad er eq uity market,"-he says. "Wehave always believed that correlations will vary depe ndingon the facts andcircumstances of each market cycle.Factors likely to influence correlations over any periodinclude initial valuations for equities and REITs, as wellas the real estate cycle and the underlying fijndamentalsand macroeconomic forces that may be specific to eitheror both."

A COMBINED APPROACHYet another approach to investing in REITs is tuse both strategic and tactical planning. "Clients whhave at least S500,000 to investwhich is most of oclientswill usually hold 10% to 20% of their portfolin non-traded REITs," says Steve Hutchinson, wh

heads a wealth management firm in Greensboro, N."In addition, we'll invest tactically in traded REITResponding to shifts in the economy, we miginvest in commercial, retail or multifaniily housinRE ITs, for exam ple."Hutchinson says that he has had clients invest in no

traded REITs for more than 20 years, with good resul"We like those REITs because you can get in at tbeginning of capital formation, so there's more potentifor sub stantial returns. Sponsors can cherry-pick the beopportunities asmoney comes in. Recently, we've seesponsors ofnon-traded REITs diversify their offeringeven including some international properties."


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If a client has, say, a S 1.5 million portfolio, around$250,000 might be invested in non-traded REITs,according to Hutchinson. "We wouldn't invest all withone sponsor," he says. "Instead, we'd spread the moneyover different types of offerings from several sponsors,including CNL, Inland, Cole Capital and Hines RealEstate. We tell these clients to expect that money to belocked up for at least five years, and probably longer, sothey should plan on holding for the duration."

In terms of specific investments, Hutchinson says,"We see opportunities in lifestyle properties, whichoffer drive-to vacations. The best locations are within 75miles of major m etropolitan areas. W e also like RE ITsthat own senior housing properties. If the housingmarket improves, older people will be able to sell theirhomes and move into [an] assisted-living[facility]. Then those RE ITs will do well."The key to any type of healthcare ormedical REIT, according to Hutchinson,is to find private-pay facilities, ratherthan those dependent on governmentoutlays." Seneff, another proponent ofsenior housing investments, adds that thelodging businesshotelsmay also offerattractive buying opportunities now.

Regarding clients with fewer assets toinvest, Hutchinson says that relativelysmall accounts get exposure to REITsthrough mutual funds. Tom Balcom,founder of IBIS Wealth Management inBoca R aton, Fla., also uses mutual funds aswell as exchange-traded funds (ETFs) forexposure to REITs. "Even if a client haslarge holdings of investment properties,"he says, "I'll still want about a 10%allocation to REITs. The client probablyowns local properties while REITs makeup a national asset class."D O W N S I D E P R O T T E C T I O I V

For many of his clients, thou gh, B alcomturns to structured notes for participationin REITs. "They can provide downsideprotection as well as upside potential. Ad -visors generally can access these structurednotes through the trading desks of majorinvestment banks."

"Advisors andclients are

interested intangible assets

that can do w el l ininflationary time s.REIT sponsors canstructu re leases

to get rent bumpsto keep up with

inflation."TIM SENEFF

CNL CAPITAL MARKETS

Among the firms offering structured notes pegged REITs are Barclays, Credit Suisse and Morgan StanleTerm s vary, but the no tes inight last from 13 to 2months. Investors' results can be pegged to the DoJones U.S. REIT Index, with the downside capped around 10% and the upside capped anywhere from 15%to 40%. Assuming the index moves up d uring the terof the note and the cap isn't triggered, investors wouget twice the index gain: a 10% return if the index is 5higher, for instance.

"The only way you can lose with these notes," saBalcom, "is if there is a huge rally and you don't p articipafuUy. My clients are willing to take that risk in returfor the downside protection." Such structured notes havother drawbackslack of liquidity, lack of cash flow froreal estate operationsbut Balcom says thmain concern is the issuing bank's financstability. "You don't want another LehmaBrothers. For safety, we spread our structurnotes among several different banks."

In general, advisors are asking moquestions about REITs, no matter whtheir strategies might be. "We're seeinmore interest from advisors on soph isticatetopics," says Larkin. "For instance, has REIT's distribution been covered fromits cash flow? Some REITs are not earning enough from operations to cover thdistribution. That's essentially the same ataking on more debt. We tell advisors look over a REIT 's public filings. Exam inthe income statement to see if the distrbution has been covered. Broker-dealealso have been helpful in educating advsors about this."

Income and low-correlation to stocks aalso on advisors'minds, according to LarkiAnd Seneff adds inflation protection as prime concern: "Advisors and clients ainterested in tangible assets that can do wein inflationary times. REIT sponsors castructure leases to get rent bumps to keeup with inflation."

Whether they take a strategic, tacticor combined approach , advisors are usingvariety of categories of REITs to diversiportfolios and provide potential upsidto clients.


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