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Diversified REITs: Where to Hide?

REITs of all kinds are getting hammered in the third quarter leaving investors with few choices

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We’re about halfway through the third quarter, and REITs of all stripes are taking it on the chin thanks to rising interest rates.

The First Trust S&P REIT Index Fund (FRI) tracks the investable U.S. real estate investment trust market. It’s flat through the first six weeks of the quarter compared to 5.4% for the SPDR S&P 500 (SPY). Diversified REITs—those investing in two or more types of real estate—have been hit especially hard. According to, all 15 diversified REITs with market caps of $2 billion or more are down for the quarter.

With a higher cost of capital, REITs have less cash to acquire new properties and lower yields for investors. Some are calling the slowdown the beginning of a secular change where REITs will go out of favor for a significant period of time. If so, it appears there’s very few places to invest going forward.

But “very few places” is much different than “none.” A couple REITs might still be worth a look:

Starwood Property Trust

Anything that Barry Sternlicht operates is worth considering. Until the middle of 2012, Starwood Property Trust (STWD) was primarily an externally managed commercial real estate lender and investor. Then, two things happened:

  1. First, it began acquiring single-family homes in Florida and other residential markets. To date, it has acquired almost 4,000 homes as well as non-performing residential mortgages totaling $450 million.
  2. Then in April of this year, it acquired Lennar’s (LEN) former commercial real estate business, LNR Property LLC, from a consortium of investors for $731 million.

In less than two years, it has gone from one reportable segment to three.

The acquisition of LNR Property LLC gives STWD a strong loan origination and servicing business that will immediately provide the REIT with greater scale in the U.S. and Europe. Through the first six months of 2013, on a pro forma basis, Starwood’s revenues increased 14% to $304 million with net earnings improving by 34% year-over-year to $202 million. LNR’s contribution represents a 75% increase in its overall revenue. It’s a game-changer.

Less noticeable is its foray into single-family homes. In its Q1 conference call, Sternlicht seemed pretty certain that Starwood will eventually spin off its residential business into its own independent, publicly traded company. Not a money-maker at this point, the real payoff comes when it sells its homes three to five years down the road.

In the meantime, it has to spend money renovating them before putting them on the rental market. But once they’re redone, the returns should be very stable.

Article printed from InvestorPlace Media,

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