As mentioned in an earlier post the REIT market has taken to heart the recent rise in short and long term interest rates. Today, Jennifer S. Forsyth in the Wall Street Journal asks the question whether it is time to sell your REIT funds.

The question is a tough one, because the funds have been among the market’s top performers in recent years, and each time they have fallen, they have quickly bounced back. Funds that invest in real-estate investment trusts returned an average of nearly 26% a year for the past three years, according to Morningstar Inc., and are up an average of 4% so far this year through Wednesday. The Standard & Poor’s 500-stock index, by contrast, has returned an average of 12% in the past three years.

Investors have good reason to be nervous now. Long-term rates have spiked lately, making safer investments in Treasury notes look more attractive relative to REITs.

Prices for commercial properties and for REITs that own them, meanwhile, seem expensive. Even real-estate portfolio managers say the funds aren’t likely to be market leaders, though they predict total returns in the high single digits to low double digits, with dividends accounting for between a third and half of the gains.

As always there are crosscurrents involved. While higher interest rates and skimpy yields make REITs relatively less attractive for most investors it may not be altogether wise to completely abandon an entire asset class. Indeed, David Swensen the manager of Yale University’s endowment in his new book, “Unconventional Success: A Fundamental Approach to Personal Investment,” allocates 20% to REITs in his model portfolio. Lynn O’Shaugnessy has a good summary of Swensen’s recommendations here. While that does not take into account current valuations, it does indicate a significant normal exposure to the asset class.

As a middle course, investors may want to consider trimming back REIT exposure as the part of a larger rebalancing program. Investors who rebalance, on a periodic basis, trim their exposure to asset classes that have performed well, and add exposure to asset classes that performed poorly. This brings their exposures back to more normal levels. The recent performance of REITs would likely bring about some trimming of real estate exposure.

As always do your homework. You can read more about portfolio rebalancing here (basic) and here (technical).

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