I didn’t get into a mall this holiday weekend, but I drove by several, and their lots were reassuringly full. At an antiques fair in upstate New York, dealers said sales were brisk, especially compared with last year. These may be random observations, but they suggest that Europe’s recent woes and volatility in the stock market haven’t dampened consumer confidence in the U.S., and the Conference Board reported last week that its index of consumer confidence in the U.S. grew in May for the third month in a row. That reinforces my view that the slump in commercial real estate, including shopping malls and office complexes, has likely bottomed.
Last week I reported that I used the latest correction and Common Sense buying opportunity to invest in commercial real estate, a sector I’d avoided since the collapse of Lehman Brothers and ensuing recession. After witnessing the carnage in subprime mortgages, I’d worried the market hadn’t adequately assessed the risks in commercial real estate. There’s no doubt that many supposedly savvy investors grossly overpaid for commercial property during the boom: Witness this year’s collapse of the Tishman Speyer-led purchase of New York’s Stuyvesant Town. But recent data suggest that rents and property values are stabilizing. Unlike most hapless subprime borrowers, many big real estate borrowers have the wherewithal to get banks to refinance and avoid outright defaults. I think the worst is likely over.
Many investment professionals, including many endowment managers, advocate an allocation to real estate as part of a broad diversification strategy. (Yale’s fiscal 2009 asset allocation model targeted 37% for real assets, including real estate, but most recommendations for individuals are far smaller, in the 5% to 10% range.) Historically real estate has provided a hedge against inflation as well as a cushion against volatility, since it hasn’t been highly correlated with equities. That wasn’t the case during the 2008-09 plunge, when real estate prices collapsed along with virtually every other asset class. But I still believe the long-term case for diversification makes sense, and I’m aiming for a 5% commitment to real estate. (I’ll increase that if prices correct further.)
Direct investment and real estate partnerships don’t make sense for any but the wealthiest individuals and institutions, since minimum commitments are high and the investments are illiquid, often tied up for seven to 10 years. But the rapid rise of real-estate investment trusts, mutual funds and exchange-traded funds have made it easy for individuals to gain access to low-minimum, low-cost, highly diversified real estate portfolios.
I put equal amounts into two REIT ETFs: The Vanguard REIT Index ETF (VNQ) for U.S. real estate and the SPDR Dow Jones International Real Estate ETF (RWX). There are many options, but the Vanguard ETF is large, actively traded, very liquid, and boasts a low expense ratio — just 0.13%, compared with the 0.52% real estate ETF average. It seeks to replicate the MSCI US REIT Index. I examined the holdings in several of these broad-based real estate ETFS, and they all own essentially the same REITs with broad exposure to office buildings, shopping malls, apartment complexes, storage facilities and hotels. Vanguard’s largest holding is large mall operator Simon Property Group (SPG), considered one of the best run REITs. In its bid for bankrupt General Growth Properties (GGP), Simon showed it had the financial strength to snap up bargains; by dropping out last month, it showed it had the discipline not to overpay. (I ended up being so impressed with Simon that I bought shares in addition to the ETF exposure.)
The SPDR Dow Jones ETF, run by State Street Global Advisors (STT), is also large, liquid and actively traded. Expenses, at 0.59%, are slightly higher. The fund tracks the performance of the Dow Jones Global ex-U.S. Select Real Estate Securities Index. The index is heavily weighted toward developed Asia and Europe, with little exposure to China and other emerging markets (I couldn’t find an ETF that focuses exclusively on emerging markets real estate, though there is one for China real estate.) RWX’s largest holding is Australia-based Westfield Group, one of the world’s largest mall operators. But strictly speaking, it’s not a pure play on foreign real estate, since Westfield is a major owner and operator of U.S. properties. (Westfield figures prominently in the portfolios of all the foreign real estate ETFs I examined.)
Both of these diversified ETFs have relatively low exposure to hotels and resorts, which I believe should continue to benefit from increased business and leisure travel. So I also bought shares in Starwood Hotels & Resorts Worldwide (HOT). It’s not a REIT, but in many ways it might as well be. Its brands include Westin, St. Regis, W, Le Meridien and Sheraton. It’s highly diversified, with properties all over the world. It was also recently trading at more than 20% off its intraday high for the year of $56.65.
Of course risks remain, especially given the recent jitters over Europe’s debt load and the possible fragile recovery. But prices of REITs and other real-estate assets have recently corrected, in most cases more than the broad market. To me, that makes an inviting entry point.
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