Weighing risks vs. rewards of real-estate trusts

Here’s a thought for the bold: Take the subprime mortgage meltdown as a buying opportunity and plunge into REITs.

But only if you have a cast-iron stomach.

A REIT, or real estate investment trust, is stock in a company that’s something like a mutual fund but specializes in buying office buildings, malls, apartment houses, mortgage-backed bonds or other real estate holdings. There are about 180 REITs of various types, plus a string of mutual funds and exchange-traded funds that invest in them.

Although investors can and do make money when REIT share prices rise, REITs also are known for their healthy dividends. This year the average dividend yield — annual dividend divided by share price — is about 4.7 percent. That’s about three times that of the average stock in the Standard & Poor’s 500.

But let's be clear up front: REITs are not a sure bet.

Like stocks in home builders and other real estate companies, REITs have been hammered by the ripple effects of the subprime mess involving high-risk mortgages for people with poor credit or low incomes. Rising interest rates have pushed up monthly payments on these adjustable-rate loans, leading many borrowers to fall behind in payments and causing huge losses for some lenders.

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This has made many lenders, even those not involved in the subprime market, more cautious about approving loans. With money harder to come by, there are fewer home buyers, home prices are falling and not as many are being built. Even non-residential real estate companies are affected because investors worry those firms too may find loans harder to get, or may suffer losses from investments in bonds backed by home mortgages.

All this has been hard on REITs. Despite the healthy dividends, the average REIT has lost nearly 10.5 percent this year through the end of August because of share-price declines, according to the National Association of Real Estate Investment Trusts, a trade group. That’s a stunning reversal from gains of 38.5 percent in 2003, 30.4 percent in 2004, 8.29 percent in 2005 and 34.4 percent in 2006.

Mutual funds specializing in REITs and other real estate investments have lost nearly 8 percent this year, while the average diversified U.S. stock fund has gained about 6 percent, according to Lipper, the fund-tracking firm. The Vanguard REIT Index Fund, an ETF, is trading at about $69 a share, down from $87 in February, for example. (Over the past five years, real estate funds have gained an average of 19.6 percent a year, vs 13.4 percent for those diversified funds.)

All REIT types have racked up losses this year, but the worst has been the 45.4 percent decline in those which invest in mortgage products such as bonds backed by home loans. When borrowers fall behind in payments, the bonds lose value.

For example, shares in RAIT Financial Trust, a mortgage REIT that finances commercial real estate, are down about 76 percent from their all-time high in February. American Home Mortgage Investment Corp., a REIT that had specialized in home mortgages, filed for Chapter 11 bankruptcy in August, making its shares virtually worthless. A similar fate befell New Century Financial Corp., another mortgage REIT, which went Chapter 11 in April. It’s trading at about 10 cents a share, down from more than $42 a year ago.

So why would anyone invest in REITs now?

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