INVESTING: REITs lose sheen as other sectors of market shine

If you avoided getting hit by the falling brick that has been the residential homebuilding sector, you may want to get ready to do another sidestep. It looks as if weakness in homebuilders is spreading to real estate investment trusts, and it is early enough to take defensive action.

Before getting into it, let me say that I believe the overall stock market has plenty of upside, despite the recent heady gains. My reason for avoiding REITs now is that I think other areas will do better.

The Dow Jones industrial average likely has another 10 percent on the upside left this year, while REITs may go up only 3 percent or 4 percent (with dividends). Of course, there will be downside action along the way, and REITs should do worse during market corrections than the Dow. More losses on the downside and smaller gains during rallies tell me to look elsewhere for opportunities.

Two of the larger and more successful U.S. REITs are headquartered here. Simon Property Group and Duke Realty Corp. are involved in different aspects of the business, but seem to be suffering from the same disease.

Both stocks are at least 15 percent off their recent highs in an environment where all other market indexes are just a hair away from either all-time or multi-year highs. The Dow Jones REIT Index just broke below a support line running from 2001. These circumstances do not bode well for longer term.

Traditionally, investors bought REITs for the outsized dividends they paid. Today, a REIT with a dividend above 6 percent is rare. Duke Realty, which concentrates on office and industrial buildings, pays just below 5 percent. Due to its strong stock performance the last few years, Simon Property, which focuses on malls and shopping centers, pays less, about 3.5 percent. More than a few industries now pay as much or more than the REITs.

Of the two local REITs, Simon looks more vulnerable than Duke. Because of its retail focus, Simon may feel the effects of a slowdown in consumer spending. The slowdown looks to be just enough to make comparisons very difficult for Simon.

I had a client recently question my bullish bias given the recent hefty gains. In light of the market meltdown earlier this decade, it makes sense to think about the downside risks. However, there are a number of differences this time around-the chief one being that in 2000 the market had been setting new highs for five years. Today, we are only seven months removed from the Dow’s all-time high, and the S&P 500 didn’t reach its all-time high until late May.

One chart after another of big-cap stocks shows breakouts from months of consolidation. Conoco Phillips is a perfect example. I believe Eli Lilly and Co. also could be ready to make a run, although I don’t expect a trip back to its all-time high of $110 any time soon.

Increasing volatility may accompany this run, but I fully expect higher prices in the intermediate term, and it could turn out to be quite a move.