Trouncing the Standard & Poor’s 500 index, the National Association of Real Estate Investment Trusts composite index of REITs posted a total return of 25.89 percent in 2000 and 15.5 percent in 2001, compared with 9 percent and 11.9 percent losses over the same period for the stock benchmark. This year through July 19, REITs delivered total returns of 0.58 percent, versus a 26.16 percent loss for the S&P.
No wonder investors are jumping into the latest investment vehicle for real estate stocks -- publicly traded, closed-end funds that offer actively managed portfolios of REITs. Since May 2001, when AIM Funds launched the first closed-end REIT fund, other money managers, including Cohen & Steers Capital Management and Nuveen Investments, have pulled nearly $2 billion into these funds. More offerings are expected.
Like all REIT mutual funds, the closed-end funds own diversified portfolios of REITs, providing juicy, relatively safe yields of about 8 percent, versus 2 percent for the S&P 500. (By law REITs must pay out 90 percent of their net income as dividends to shareholders.)
“Closed-end funds are the flavor of the day,” says Mark Patterson, head of real estate investment at Salomon Smith Barney. Salomon underwrote AIM’s closed-end REIT fund, which raised $543 million last May. Says Patterson: “It’s hard now to find a relatively safe yield instrument with a diversified base of companies. With closed-end funds that’s what you’re getting.”
But not everyone finds the funds so tasty. Some Wall Street research analysts object to the way certain funds construct portions of their portfolios. Like the unit investment trusts that bought $4 billion in direct stock placements during their heyday in 1997 and early 1998, some of the closed-end funds buy a portion of their shares directly from the REITs rather than on the open market. By doing so, the funds can secure shares at a discount -- a benefit not available to outsiders.
REITs offer a certain number of shares at discounted prices -- typically 5 percent -- to closed-end funds; the deals are registered private placements. But unlike other private placements, the REIT shares that change hands are unrestricted and can freely trade. “Other REIT shareholders don’t get a chance to participate in these deals,” says David Shulman, a real estate analyst at Lehman Brothers. “They’re discriminatory.”
Fund managers insist that they’re offering a good deal to their own fundholders. Says Greg Brooks, a portfolio manager at Cohen & Steers, “The individual investor is the one who benefits.”
The UIT wave reached its peak in mid-1998, when Cohen & Steers launched a $1 billion real estate UIT, with shares garnered solely through direct placements. But then REITs got hammered. Amid fallout from the collapse of the ruble and the meltdown of Long-Term Capital Management, the Nareit index declined 18.8 percent in 1998 and 6.5 percent in 1999. During this period and throughout 2000, investors shunned both REITs and the UITs that owned them.
But with the REIT resurgence last year, Wall Street looked for a new investment product to channel commercial property assets to a hungry public.
Unlike UITs, which typically had a three- to five-year existence, today’s closed-end funds are actively traded and have an unlimited life span. In addition, the closed-end funds generally have more modest direct placement positions than their UIT forerunners. Although Cohen & Steers’ 1998 $1 billion UIT consisted entirely of shares bought directly from REIT management, its $510 million Quality Income Realty Fund, which closed in February, acquired only 41 percent of its shares through direct placements.
For the moment, at least, investors like the mix. “Brokers are selling these for one reason: They’re easy,” says Geoff Bobroff, president of Bobroff Consulting.
