REAL ESTATE --REIT (R U KIDDING ME?)

For several months, readers have periodically asked me about various Real Estate Investment Trusts. Several of the inquiries have been about REIT that invest in real estate mortgages and sometimes about REIT that buy real properties (some leveraged and some not).

The responses received show that I have not communicated effectively. Let me try again,

REAL ESTATE INVESTMENT TRUSTS ARE
DANGEROUS!

All stock market investments have risk. It is my belief that the actual risks of REIT is greater than the perceived risk. Buy these at the right time and you make a lot of money but be careful.

Let me share some numbers to make my point. The source of these numbers is the Chase Investment Performance Digest.

During the real estate recession of 1973-74, REIT declined 45.49% in 1973 and 79.22% in 1974. One thousand dollars invested at the start of 1973 declined to $113 by the end of 1974!

The above numbers are not a one time event. Another example is the real estate recession that ended in 1991. Here are the numbers, 1987 negative 29.76 percent, 1988 positive 4.03 percent, 1989 negative 21.88 percent, 1990 negative 43.62 percent and 1991 positive 5.66 percent. One thousand dollars invested on January 1 1987 declined to $321 by the end of 1991 and had "recovered" to $340 by the end of 1992.

The person who put his money in a shoe box, waited for the recession to be over and invested $1,000 on January 1, 1975 made serious money the next two years. The returns for 1975 and 1976 were 27.34% and 38.65% respectively. One thousand dollars grew to $1,765 in two years. The investor who bought on January 1, 1973 and held through 1976 watched his $1,000 drop to $173 in just two years and saw it quickly recover to $305 in the next two years.

The same deal in 1992 and 1993. The returns after the recession were 22.18% and 16.57% respectively.

NO, I am not suggesting that we are entering a real estate recession. My forecast remains that long-term interest rates (including mortgage rates) will move-up a small amoung this year. The mortgage version REIT will be able to extend the good run a while longer because each time the prime rate goes up, a few more holders of variable rate home mortgages will be scared into refinancing to get a fixed long-term rate and the mortgage company will earn additional fees.

My guess is that the next Real Estate Recession will occur around 2009-10. Four or five years is not a long time. Note the return of the real estate trust in 1987--three years before the worst year of the decline. The real estate market is hot right now and money will be made by buying real estate now. One simply should be fully aware of what one is buying. With my money, I will avoid buying companies that lend money to others to buy real estate and I will try to avoid buying companies that use leverage to buy real estate.

Naturally I will buy companies that buy real estate for the use of the company. There is a huge difference in buying a factory to use and buying one to rent to others. The same for a home or second home. Home prices are not volatile and the net cost to the owner is typically less than the cost to rent.

Folks wonder how a company holding secure mortgages can lose. The key point is that if the real estate declines in value below the loan balance, the collateral is worth less than the amount owed. Banks and mortgage companies typically lend only a small fraction of their own money. They borrow about 92% of the money they lend. If they lose 8% of a $100,000 loan, they lose 100% of their investment.

The risk is real, be careful!

There are many investment pitfalls. A portfolio review is available to you free of charge. Write me at jackmiller@triad.rr.com to get a free review from an amateur with 42 years investment experience. Bobby Jones, one of the best golfers of all time, was an amateur. I don't pretend to be even a good golfer but as an investor I am not bad. I would appreciate the complement of reviewing your situation.