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The Honolulu Advertiser

Posted on: Friday, May 23, 2003

Real estate mutual funds bring stability, diversity, strong returns to portfolios

By James K. Glassman
Washington Post

WASHINGTON — Are real estate stocks just too good to be true?

It certainly seems that way. Take Vanguard's REIT Index (VGSIX), a mutual fund that's a good proxy for the entire sector. So far this year, it's up 10 percent. For the past three years, it's returned a total of 45 percent, compared with a loss of 31 percent for the benchmark Standard & Poor's 500 Stock Index. And those gains were achieved with shockingly low risk. The real estate stocks in the portfolio were more than 80 percent less volatile than the market as a whole.

The Vanguard fund was launched only in 1996, so for more history check out Cohen & Steers Realty Shares (CSRSX), another broadly diversified fund. Over the past 10 years, it's returned an annual average of 9.7 percent, a tiny bit ahead of the S&P, but, again, at risk levels that are between one-third and four-fifths lower than the market, depending on which gauge you use.

Risk counts. Most investors can't bear returns that bounce wildly up and down from year to year. Volatility provokes mistakes such as selling at the bottom. A smooth ride is what we crave, especially if it's a lucrative journey.

How smooth is real estate? Very. Between 1992 and 2002, the Cohen & Steers fund declined in only one calendar year. In the others, its returns ranged from a low of 3 percent (1999 and last year) to a high of 38 percent (1996).

In fact, real estate stocks — especially real estate investment trusts, or REITs, which have special tax treatment — behave so differently from the rest of the market, they're almost a separate asset class rather than a separate industry.

This divergence — in financial jargon, "low correlation" — is something else we crave. If your portfolio includes assets with low correlations, it means that when some investments are declining, others are declining less, or even rising. You don't have fantastic years, but you don't have wretched years, either.

A recent study by Sanford C. Bernstein & Co., the research and money-management firm, found that, between 1991 and 2002, REITs had a correlation of just 0.3 with the S&P 500. In other words, only 30 percent of the movement of REITs can be explained by the movement of the market as a whole. By contrast, a portfolio of international stocks over the same period had a correlation of 0.66.

At a time when a 10-year AA-rated corporate bond is yielding just 4 percent, REITs are mouth-watering. Kimco Realty Corp. (KIM), one of the largest REITs, specializing in community shopping centers with classy tenants, has a dividend yield of 5.8 percent; Another solid REIT, Duke Realty (DRE), has a dividend yield of 6.5 percent; Equity Residential (EQR), a giant REIT that owns 223,591 rental units, yields 6.3 percent.

It's hard to argue with the results of REITs like Washington REIT (WRE) — a company that owns a mix of office buildings, apartment complexes, small shopping centers and industrial distribution centers that has raised its dividend for 32 straight years. If you had bought 1,000 shares of Washington REIT in 1987, your dividends that year would have totaled $580; this year, they would total $1,450.

Certainly, there are no guarantees REITs will continue to offer high gains at low risk (some analysts think we are in a residential real estate bubble, similar to the high-tech bubble). But, considering their history of the past decade in good markets and bad, I find it hard to ignore real estate.