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If the overall real estate market is in a slump, should this be considered a time to BUY stock in real estate companies and Real Estate Investment Trusts (REITs)?!

The quick answer is no, or probably better said… not necessarily. But let’s examine why that is…

1. There are many types of real estate companies out there. Some focus primarily on office space and commercial properties. Others might focus on retail space such as malls, or even hotels and hospitality locations. Not all of these areas are in a funk like the residential market. For instance, since the collapse of the World Trade Centers in New York there has been an office space shortage in Manhattan while there is a surplus of office space in other cities. So just because there is a slow down in many areas for residential real estate, those same areas could be quite healthy for commercial properties, etc.

Also, some REITs are diversified or focus on mortgage products. Those stocks that are tied more to mortgages are more dependent upon the movement of key interest rates.

A quick side note on what a REIT is… this is essentially a real estate company that has complied with an IRS rule to designate the company as being primarily engaged in the real estate business and furthermore pays out 90% or more of its earnings in the form of dividends to its owners. You can read a more detailed answer in the Investopedia.com article entitled What are REITs?

2. Real Estate is a long-term investment for most individuals… well the same holds true for most companies. Not many (if any at all!) of the companies that are traded publicly are into “flipping” properties. Most companies hold these properties for many years to make money on the rental income. The transaction costs of buying and selling real estate makes it cost prohibitive to buy and sell property on a frequent basis (much like the transaction costs to your stock broker makes it prohibitive to trade stocks rapidly).

Many of these real estate companies have been buying property before, during, and even after the market’s ascent and then into its decline. The effect of such buying can be similar to the concept of dollar cost averaging the purchase of stock. So to think that these companies are at a low, well, we go back to the first item and say it depends on what type of real estate they are involved in and how well that sector is doing. Various companies will have different strategic methods of operation, even within the same industry, leaving some companies in better position than others to take advantage of a soft market (acquisition/buying opportunity) or better guarded against a slowing real estate market.

3. As interest rates climb, the real estate companies’ cost to borrow money increases limiting the amount of real estate investment the companies can do as well as limiting the number of buyers they would have for their existing owned properties. Another excellent article from Investopedia.com points out that there is a strong correlation (link) between the falling stock price of a real estate investment trust (REIT) and a simultaneous increase in key interest rates. The article is titled The Impact of Interest Rates on Real Estate Investment Trusts

The bottom line here is this… before you decide to purchase a real estate-based stock or some stock in a real estate investment trust, do your homework on what type of real estate the company is involved in. Look to see how the company’s stock will be impacted by changes in the interest rates or how that company’s peers are doing in comparison. It pays to find the “best of breed” as Mad Money tv show host and TheStreet.com co-founder Jim Kramer would say… and this is true regardless what the housing market or any other type of real estate market is doing.

As always, I welcome your comments and feedback…