U.S. REIT Markets

David Levy
Co-Portfolio Manager
Franklin Templeton Real Estate Advisors

As a sector, U.S. publicly traded real estate was not spared in the global market decline that began in late 2007. Perhaps one silver lining for investors is that over this period we believe valuations of many of these companies have become quite favorable, and as a result, Franklin Templeton Real Estate Advisors considers this an opportune time to invest in the sector. At present, the net asset value discounts have ranged from about 20% to 25% across the U.S. real estate investment trust (REIT) group.

In our view, macroeconomic fundamentals have a while to go before they reach bottom, but historically, U.S. REIT stocks have led economic recoveries by anywhere from six months to a year. We believe that the market is close to that time period, and as a result, we think we are approaching a very favorable moment to buy these stocks.

Investing in real estate as part of a larger portfolio may provide important diversification benefits. In recent years, real estate has really come into its own as an asset class, gaining wide acceptance within the U.S. and globally as pension funds, endowments, universities and the like have discovered real estate as a valuable component of a diversified portfolio. Historically, real estate and real estate investments have been able to generate relatively consistent income, similar to bonds, because of their dividend component, and yet they offer the potential for equity-like growth or upside. In the case of hard real estate assets, steady cash flows from lease agreements and annual rent increases help create potential appreciation in capital values and may serve as a natural hedge against inflation.

At Franklin Templeton Real Estate Advisors, our approach to managing real estate funds has been to overweight what we believe to be higher-quality companies that have more secure-and generally higher-paying-dividend yields. Often these are more established REIT companies with long operating histories and sound management teams. We also seek to lower volatility by avoiding what we consider to be higher volatility groups, such as homebuilders.

REITs will continue to deal with a number of challenges in the next few years. Industry net operating income growth may be quite small for some time to come because of declining rents for office buildings, apartments and shopping malls. Also, a large number of REITs accumulated excessive debt during the property boom from 2005 to 2007, and many will need to keep raising additional equity to reduce their debt levels. In the next few years, REITs will also face the burden of refinancing a large amount of debt that is set to mature. However, these challenging conditions may provide the more-conservatively leveraged and well-capitalized REITs the opportunity to acquire assets at discounted levels.

In fact, we are noticing that higher-quality, publicly traded REITs are still paying their full dividends. Those dividends are well covered by the underlying properties' cash flows that are generated, in turn, from leases signed by tenants. Also, in most sub-asset classes within the overall REIT sector, whether retail or office properties, leases are longer-term in nature, generally five to 10 years. Therefore, among the names that we invest in, we still see full dividends being paid and, in most cases, fairly attractive yields.

Please click for more information on the following funds:

FTIF - Franklin Global Real Estate (USD) Fund
FTIF - Franklin Global Real Estate (Euro) Fund