The real estate market is showing signs of getting better, but should you bet your retirement portfolio on it staying better?
Let’s start with the better news regarding one of the worst fears in the real estate market: foreclosure.
Over the past 12 months, the rate of lenders forced to deal with getting back the keys to residential properties has been falling; it’s down more than 27 percent. And the number of those that are headed that way (in arrears for more than 90 days) is down from the past year by more than 4 percent.
So perhaps things are improving from one of the worst recent markets in a while. But are we turning up from a bottom and ready to continue to rally?
Right now, there are plenty of speculators and bottom fishers — and we all dreams of these deals — that are risking that there are some massive gains to be made. But, even if you could buy distressed real estate on the mend, should you really consider putting your retirement at risk? What if you don’t make the right call on the right properties at the right times?
None of us are getting any younger. And if you’re working on funding your future retirement or are relying on your portfolio to pay your daily bills, you can’t take gambits right now.
That’s not to say that there isn’t some real money that’s being made right now in real estate. And it isn’t just by those picking off foreclosed property deals on resort properties in Florida or Nevada. Rather, money has been made in broader improvements in real estate investment trusts (REITs).
REITs have been on a recovery tear since the massive market meltdown of 2007-2008. Since the bottom in March of 2009, REITs have rebounded by more than 290 percent, paying above broad market dividend yields along the way.
But before you start thinking that this market hasn’t been without issues, the same broader REIT market has had some downs over the past 12 months, including the near 8 percent plunge last spring and the nearly 10 drop last fall. So, no, this isn’t a one-way, sure-thing bet for anybody.
This doesn’t mean that there aren’t some solid real estate assets that you can trust part of your portfolio with. In fact, there are some very strategic property types in key locations around the United States and beyond that have continued to perform.
But before I get to one of my newfound segments, there is one more thing that you need to know before we start shopping the property markets. Rather than looking at just buying into regular REIT shares (whereby the dividend yields have been driven down with some of the recent stock price actions), you need to be a bit more selective.
So right now, I’m returning to a segment in the preferred segment of the REIT markets that did very well for me a few years ago. It can provide a higher dividend and more security with less market and company risk.
As a preferred shareholder, you’re put a step above the regular common shareholder when it comes to getting paid your dividends as well as dealing with any meltdowns.
Most of the market gurus have been focused on the regular common stock REITs. But for me, the real, heavier cash flows can be much more easily found in the preferreds.
Although preferred shares of REITs might be up the credit ladder and have a better call on dividend payments than common shares, you still have to pick the right REITs. Otherwise, it won’t matter what kind of shares you own; they won’t be able to pay, and you can lose your shirt faster than you know.
The key is to have some discipline in the whole selection process. This starts, of course, with the right properties and focus of individual REITs. Then, put them through their paces.
This means that you need to own REITs that have proven to own and manage the right mix of assets that have been generating a rising stream of revenues. In addition, the properties have to perform including covering costs.
This means looking at the funds generated from operations and then subtracting operating costs and seeing fatter margins to deliver solid returns on the invested assets and the equity of the shareholders.
But that’s just the front end of the business of running a REIT. After finding the select collection of REITs with the right properties that are performing well and being managed for profits, you need to turn to the financial risk.
This is the stress test of the investment selection. First, you need to look at the liabilities. With credit markets improving (but being far from fixed), the successful REITs need to be reducing liabilities — even if it means contracting a bit in asset size.
Then, like with any investment company, the ability to service existing debts as well as being able to keep and attract new creditors is ever more crucial.
This means looking at the debt coverage, which had better be solid. Don’t look just at the properties; they can take time to liquidate. Look also at the cash on hand coverage of pending liabilities.
Then you need to look at the existing debt and when it has to be repaid or rolled over. From revolving bank credit facilities to bank loans and even bonds, the REIT had better have plans on how to deal with rolling over or paying off every bit over the years to come. If it doesn’t, it shouldn’t make your final cut for your retirement portfolio.
The bottom line is that if you wouldn’t lend to any of these REITs, you shouldn’t even think about buying any of their shares — preferred or common.
Now that you have a bit of my stress testing methodology, how about an example from a segment that’s actually working and will keep working in real estate?
More and more people are recognizing that owning their primary residences may not be a necessity. Having flexibility by not having so much of their net worth tied to a single home and single market has become a much more desirable goal.
Of course, those who don’t have the means of dealing with ramped up equity requirements for mortgages are left with the necessity of renting.
The concept of being a tenant rather than an owner is also increasingly becoming a socially accepted norm. So whether by necessity or choice, renting is ramping up in demand.
In fact, according to recent property surveys, the number of people in the United States alone that are renting their primary residences has been climbing by more than 11 percent.
With this improvement in demand, apartment vacancy rates for grade A rentals are down more than 44 percent over the past few years.
This is where multi-family property REITs come in. They are the defensive part of the real estate market.
One of the attractive companies in this segment is Apartment Investment & Management Co. (AIV). Apartment Investment and Management has properties throughout the United States, so you can end up with a nice national mix of rent-generating apartments and residential properties.
Apartment Investment and Management has been reducing its liability balances by some 8.5 percent, resulting in a better balance sheet. Revenues have turned up, and operating cost controls should result in improving margins. Returns on equity are in the 15 percent to 16 percent range.
Its ability to cover its debts and service its dividends to shareholders should continue to improve. And its abilities to attract creditors for mortgage and other debt should be good, since both Moody’s and Standard & Poor’s gave the company a stable rating.
Apartment Investment and Management has a preferred share (series “Z”) paying a dividend rate of 7 percent that’s trading at about $26.90, giving you a yield of more than 6.5 percent.
Make sure that you’re looking at the preferred share and not just the ordinary REIT by using the symbol on the New York Stock Exchange of AIV-Z or use the CUSIP number of 03748R770.
— Neil George