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REITs invest in commercial, not residential real estate.
Actually they invest in both:
A REIT invests in a pool of mortgages and/or properties. There are 3 kinds of REITs: mortgage, equity, and hybrid.
Mortgage REITs use investors' money to buy mortgages.The REIT does not own any property; it loans its money to a property owner or owners, the loan(s) being secured by the property(s). The property owner makes mortgage payments each moth to the REIT.
Equity REITs use shareholders money to buy real estate. They generally specialize in a certain kind of project or geographic region. Some REITs buy only strip shopping centers, others concentrate on nursing facilities; still others buy commercial or
residential property in a specific state or region. Depending upon the kind of real estate you want to include in your portfolio, chances are there will be at least one equity REIT that specializes in that area.
Hybrid REITs are a combination of a mortage and equity real estate investment trust. They invest in real estate and also purchase mortgages or make loans.
Style-wise they're considered small, value stocks. Consequently, they're a very different asset from residential real estate.In addition, the majority of REIT income comes from managing nation-wide commercial property, not buying and selling it. Therefore, the current housing bubble (if it is a bubble) doesn't directly impact REIT returns.
Real estate may seems to "act" like stock at time, but dont make the mistake of not recognizing that it is a completely different asset class, because as you correctly pointed out, it has no correlation to the stock market. Real Estate is real estate, stock is stock. "Value" stock, is still stock, not real estate. And personally I dont think it acts like value stock since a value stock by definition is "undervalued" (was that redundant?) and once it becomes overvalued, its no longer a "value" stock. In contrast, Real Estate can be both undervalued and overvalued depending on the market. Also, Whenthe real estate market finally does "collapse"like a rocket that ran out of fuel in the near term, you wont think they act like value stock either. Even small cap value usually doesnt "collapse".
As for the commercial/residential distinction you're trying to make, I assure you when you here that "the real estate market is collapsing", every REIT fund you can find, both those that focus on residential or commercial real estate,will be heading south.
Since 1993 REITs have returned 12.5% a year with a standard deviation of 16.8%. In contrast, the S&P 500 has returned 12.7% a year with a standard deviation of 20.3%. The correlation between REITs and the S&P 500 during that period was .02.
That is a good point from the standpoint of trying to diversify. However, REITs (commerical and residential) have exploded over the past 5 years, per my initial point. (look at american century's REIT fund for example, ticker REACX) Im all for diversifying, but I cannot recommend accomplishing that by buying into Real Estate at its peak.
>Another point: Generally speaking, REITs are interest rate sensitive. When rates fall, mortgage REITs usually appreciate in value, just like long-term bonds. If interst rates fall and public confidence is relatively high, equity REITs usually appreciate too. Conversely, when interest rates are rising (such as now), a REIT may decline in value unless its income stream is tied into CPI adjustments.
For a discussion of how REITs fit into a long-term, diversified portfolio see a Random Walk Down Wall Street by Burton G. Malkiel.
As i said, real estate makes a great portfolio fit.Since im a homeowner with a sizable mortgage, i'm comfortable with limiting my overall real estate exposure to just that.
