The U.S. real-estate market has stormed back over the past five years after enduring its most brutal period since the Great Depression. The rebound has rewarded investors and boosted the overall economy.

The Dow Jones U.S. Real Estate Index, whose components include real-estate investment trusts as well as mortgage, realty and forestry companies, has climbed 92% since early 2009. That gain, amid a rise of about 20% in the median price of new and existing homes over the past two years, is a bit less than the 114% rise for the S&P 500 index. But it's an impressive recovery for a sector devastated by a historic slump starting in mid-2007.

Now, however, there are growing signs of a slowdown. While the current weakness could provide investors with an opportunity to place new wagers at lower prices, analysts warn that the environment has become more challenging. If the Federal Reserve begins raising interest rates next year, as expected, it could become harder to make money from real-estate investments, the analysts say.

Home prices around the U.S. rose 9.3% in May from a year earlier, according to the Case-Shiller index. But that rise was less than forecast and represented the lowest annualized gain since February 2013. On a monthly basis, home prices fell 0.3% in June, the first negative month since January 2012.

Peter Boockvar, chief market analyst at Lindsey Group, notes that the supply of homes for sale today represents 5.8 months of demand, the most since October 2011. All regions have seen declining new-home sales lately, and new mortgage applications are also slipping.

"The first-time home buyer is just not the factor that it once was," he says. "Without the first-time home buyer, and now with a reduction in the pace of investor purchases, the recovery will remain lumpy."

For home buyers, the slowdown is good: Slowing price gains and low interest rates make homes more affordable.

"From an individual perspective, the best investment you can make is to buy a primary residence," John Paulson, who runs hedge fund Paulson & Co., recently said. "Today financing costs are extraordinarily low. You can get a 30-year mortgage somewhere around 4½%."

It's a much more challenging environment for real-estate investment trusts, or REITs. These are shares of firms that own and operate hotel, office and other commercial real-estate, and invest in mortgage securities (though the category can include companies involved in other industries). They pay at least 90% of their taxable income to shareholders as dividends.

REITs have been among the best performers for much of the year, partly because they yield nearly 4% on average. That's attractive in a low-rate environment. The MSCI U.S. REIT Index is up about 15% this year, well ahead of the overall stock market.

But REITs could come under pressure if interest rates rise. Last week, yields on 10-year Treasurys climbed as evidence grew that the U.S. economy had firmed, making a rate boost more likely. Further, REITs are considered expensive based on "adjusted funds from operations," a widely used metric for valuing these shares.

Risky Bets

As worrisome: The best-performing REITs have been those associated with more debt and risk, says Mike Kirby, director of research at Green Street Advisors, which specializes in REIT research. "Smaller, highly levered REITs with lower-quality property portfolios [have] outperformed," Mr. Kirby says.

Larger, high-quality REITs with lower levels of borrowing have tended to do better over the long term, so they're a better bet during the new period of uncertainty, some analysts say.

Examples of safer and attractive REITs, Green Street says, include Sam Zell's Equity Residential (EQR) and Retail Properties of America (RPAI), which have dividends of approximately 3% and 4%, respectively.

Still, it's likely a mistake to become too bearish on housing. Analysts at Barclays still expect housing prices to rise about 7% this year. Las Vegas, San Francisco and Miami remain strong, while Cleveland, Charlotte, N.C., and New York have lagged.

"Double-digit home-price gains were unsustainable" because income growth has been about 2%, says Mr. Boockvar. "We should be cheering slower home-price gains, not fearing them, because it is the main factor that will entice the newly created household to consider buying instead of renting."

Todd Mansfield, chief executive of real-estate developer Crescent Communities, encourages investors to look at REITs and other companies focused on the Sunbelt region. "A growing employment base has helped to diversify and strengthen that region's economy, especially in secondary cities such as Austin, Nashville, Raleigh and Charlotte, N.C.," he says.

REITs including Camden Property Trust (CPT), Mid-America Apartment Communities (MAA) and Associated Estates Realty (AEC) are focused on the Sunbelt, Mr. Mansfield says. He's a fan of office REITs including Highwoods Properties (HIW) and Cousins Properties (CUZ).

Some home builders, such as WCI Communities, which left bankruptcy five years ago, also could do well because they focus on growing areas such as Florida, Mr. Mansfield says. "You can still invest in real estate but your head needs to be on a swivel and you need to be ready to get out fast" if rates rise and the overall investing environment sours, says Matthew Tuttle, who runs Tuttle Tactical Management.

He recommends exchange-traded funds that focus on REITs such as the SPDR Dow Jones REIT (RWR) and iShares US REIT (IYR). ETFs give investors a low-cost, diversified way to invest in real estate and are actively traded, enabling them to buy and sell easily.

 

Orignial Article By: Gregory Zuckerman