Real estate investments aren’t for everyone. For one thing, many of us have a high percentage of our net worth tied up in our homes.
Still, real estate offers a better yield than high-grade corporate bonds or blue-chip stocks, so a modest real estate holding offers both diversification and extra income.
But beware: Real estate is especially vulnerable to business downturns, so we should only be investing for the long term.
REIT = Real Estate Investment Trouble?
Another problem is that a few seemingly attractive investments – such as real estate investment trusts (REITs) – are actually quite dangerous right now.
Eight years of cheap money has made developers overconfident, leading to a glut of space. This is especially true in the hotel industry, where too many “great years” are producing the inevitable overhang.
Meanwhile, in retail real estate, the demand for retail space is in a secular decline. Large chains like Sears Holdings Corp. (SHLD) are perpetually making losses, waiting only for the next downturn to throw in the towel.
Then there’s the problem with REITs themselves.
That is, REITs present an inherent conflict of interest, with groups selling participation in real estate vehicles to outside investors without having truly independent managers themselves.
There will inevitably be a tendency to pass the doubtful projects onto the REIT while keeping the good ones in the parent company.
Finally, the fancy returns in home mortgage REITs such as Annaly Capital Management Inc. (NLY) have been generated by borrowing in short-term markets and investing in fixed rate mortgages on a levered basis.
That’s been a great game since 2009, but it’s less attractive now that the gap between short-term and long-term rates is narrowing, and it will become highly dangerous once short-term interest rates start rising.
One mortgage REIT that suffers less from this extreme interest rate risk is Resource Capital Corp. (RSO). RSO invests in commercial, industrial, and multifamily residential loans, mostly carrying a floating interest rate with term funding for much of its portfolio.
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