A Real Estate Investment Trust [REIT] is a company that purchases and manages real estate investments. Some REITs also purchase real estate loans and/or mortgages. Shares of these companies are listed for trading on the US stock exchanges and investors can buy them as long or short-term investments. Options are also listed on many REITs. As a sector, the group has performed exceptionally well over the past few years. However, recent events also highlight some of the risks of owning REITs shares.

Not all Real Estate Investment Trusts are the same. Many specialize in certain areas of real estate like mortgages. Others focus on actual real estate including commercial properties such as shopping malls and office buildings or apartments and other residential properties.

REITs are different than other companies because they can be considered a portfolio of real estate holdings. These funds are also required to pay out most of their profits in the form of dividends. As a result, many have high dividend yields. One example is Equity Residential (EQR). It trades for $47.50 a share and pays an annual dividend of $1.85, which gives it a dividend yield of almost 4% (1.85/47.5). The high dividend yields make REITs attractive investments to income minded investors.

Yet, while Real Estate Investment Trusts pay often pay high dividends, owning them is not without risks. For example, REITs that hold properties within a specific geographical area can take a hit if a real estate values fall in that region. Rental property REITs can see profit margins shrink if interest rates fall and more consumers become homebuyers. On the other hand, as we have seen recently, problems in the subprime mortgage market can derail the shares of REITs that specialize in real estate loans. In short, the risks of each REIT will depend on its specialty or niche.     

Instead of trading individual REITs, some investors might prefer to hold a diversified portfolio. This is possible with the iShares Cohen & Steers Realty Majors Index Fund (ICF). The table below shows the funds top ten holdings. The largest trust, which accounts for 8% of the value of the fund, is the Simon Property Group (SPG). The REIT holds mostly shopping malls (column 3). Others hold office space, apartments, storage, or industrial buildings.  

Figure 1 shows the longer-term performance of the ICF. It is nothing short of stellar. From its lows in February 2003 to its highs in February 2007, the fund tripled in value. However, over the past few weeks, ICF has been under pressure. Amid worries about housing and subprime lending, it has suffered a three-week 10% slide.

Figure 1: ICF Weekly Chart   

Options on the iShares Cohen & Steers Realty Majors Index Fund are actively traded and can make interesting sector plays for strategists looking for ways to profit from the next major change in the real estate market. For example, a strategist expecting the correction to continue might consider bearish spreads, straddles, or strangles. On the other hand, those strategists expecting the sector to stay strong might buy shares for the 2.7% yield, create debit spreads, or maybe even put a collar on the ICF.


Frederic Ruffy
Senior Writer & Index Strategist
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