Most investors who are looking to diversify their portfolios with real estate know they can turn to real estate investment trusts for access to fairly standard holdings such as office buildings, multifamily homes or hotels. But beyond that is a second layer of publicly traded REITs focused exclusively on some rather unusual properties — from cell phone towers to FBI field offices.
These lesser known REITS, often referred to as specialty REITS, have started to outgrow their name in recent years, becoming more mainstream as some sectors, such as self-storage REITS, have performed well. Of the 166 REITs tracked by the National Association of Real Estate Investment Trusts Inc., a membership group for REITs, roughly 45, or close to 30%, could be considered specialized. Advisers, however, are still weighing the risks.
“They are an interesting play from a cash-flow perspective, but clearly have some real risks, said Duncan Rolph, a managing director at Miracle Mile Advisors. Those risks include low trading volume and an over-reliance on specific industries.
Because they are hard to categorize, limited data exists on the growth of specialty REITs. The category itself is fairly open-ended — a company can be considered a REIT as long as at least 75% of its revenue comes from real estate, which is defined as land and the improvements on it, according to Ron Kuykendall, vice president of communications at Nareit.
Specialty REITS were introduced in the late 1960s as a way for investors to buy into microwave towers. Billboard REITS came along in the 1990s, and then came self-storage REITs, which benefited from the 2008 mortgage crisis when homes were foreclosed. They have multiplied in the past decade and now include data storage centers, multiplex theaters, prisons and others.
ACCESSING CAPITAL MARKETS
“What you're seeing as of a couple of years ago is a focus on creativity in the market, and in how real estate can access the capital markets,” said Daniel Crate, chairman of Easterly Government Properties Inc., a REIT focusing on FBI offices and other government properties. The REIT went public in February under the ticker symbol DEA. “It's becoming less about the manager and more about the assets.”
Nareit no longer uses the term “specialty” in describing these REITs, and considers self-storage REITs its own sector. Self-storage units provided a total return of 31.44% in 2014, according to data from Nareit.
The Dow Jones U.S. Specialty REITs Index also performed well last year, growing 19.58%. The index is up about 60% in the past five years.
“The industry has evolved to provide specialized structures to house specific elements of the U.S. economy,” Mr. Kuykendall said. “Consistently, over long periods of time, it has outperformed the S&P 500.”
CAN GOOD TIMES LAST?
Some advisers, however, worry that the good times can't last. For Mr. Rolph, some of the companies are still too specialized. Many of the REITs have low trading volume, which means that if a big investor is spooked or exits its position, it could cause a sudden drop in value for that REIT. That's a risk conservative investors who are looking for bond alternatives might not be able to stomach, Mr. Rolph said.
“It's a very, very thin asset class,” he warned. “There's not a whole lot of depth to this market, so if things go bad and you get a liquidity crunch, you're going to have big gaps [on the way] down in the pricing.”
The other concern is that because they are so specialized, niche REITS have a high level of risk inherent in the specific industry they represent, Mr. Rolph said. New and unpredictable regulations on cellphone companies, for example, could quickly alter the value of a cellphone tower REIT, he said.
“You have to be careful when you look at the ways in which you can introduce meaningful risk,” Mr. Rolph said. “When you're an investment adviser talking about replacing bond income or at least a portion of it with this, then you don't want this to be as volatile.”
Mr. Crate, whose government properties REIT has a daily trading volume of about 4,300 shares, said volume is low mainly because the REIT is not well-known, having just recently gone public. On the flip side, the low volumes mean investors have more to gain if interest grows in the stock, he said.
“Bigger is not always better,” Mr. Crate said. “As people recognize value and the businesses grow, there's greater opportunity out there for appreciation.”
Investors must understand the fundamental business they are buying into, and they need to research the manager, Mr. Crate said.
“It's hard to have transparency as to the fundamentals that will change the price of the real estate,” he said. “You have to have a lot of trust in the manager.”
Meanwhile, specialty REITS remain in limbo as investors wait to see what will happen to the real estate market when the Federal Reserve raises interest rates. As of the end of June, many specialty REITS that had seen dramatic growth in the past five years were down about 8% to 12% from their 52-week highs.
“In a moderately rising rate environment, they're going to do OK,” Mr. Rolph predicted. “Probably not great, probably not bad.”
