A Yen for Yield Could Rock U.S. REIT

By JUSTIN LAHART

U.S. real-estate investment trusts are big in Japan. That could turn into a problem for U.S. investors.

In a low-return world, the steady dividends U.S. REITs provide have made them an investor favorite, especially in Japan, where the central bank is going all out to end two decades of stagnation that has left an aging population desperate for income.

 
Japanese investors have poured money into funds that invest in U.S. REITs and that offer dividend yields that far-and-away exceed yields on the REIT's themselves.

The yield on the Vanguard REIT exchange-traded fund, for instance, is 3.2%. In yen terms, due to that currency's weakening, it would be 2.7%. In contrast, the largest Japanese REIT fund, the Shinko U.S.-REIT Open Fund, sports a yield of 17.5%. The Daiwa America REIT Fund, pays out 18.4%.

The Japanese funds' ability to sustain such yields looks iffy. That could put U.S. REIT shares at risk, because of the large holdings some of the Japanese funds have amassed in them.

The reason the Japanese funds' yields are so high? They distribute not just the dividends their REIT holdings generate, they also base payouts on what can be unrealized capital gains in the REIT shares.

So if U.S. REIT shares rise, the Japanese funds pay out all or some of those gains to investors, even though they may not have sold their holdings.

Moreover, when investors are putting new money into the funds, the funds needn't sell shares to make distributions, because they can simply recycle fresh cash inflows back to existing investors.

Because REITs have risen so much lately—especially when seen through the prism of a yen that has fallen 18% against the dollar in the past year—the funds have been able to pay handsome monthly dividends. The offset is that the funds' net-asset values don't reflect the share-price gains that U.S. REITs have seen.

While the MSCI U.S. REIT index is up 45% in yen terms over the past year, the net-asset values of big Japanese REIT funds haven't risen as much.

The danger is that, if the music stops playing, the Japanese funds could be in a precarious position.

Here's why. Say prices of the U.S. REITs stop rising, and the yen stabilizes. Then the Japanese funds will no longer be able to pay such generous dividends without selling off some of their holdings.

This could depress some U.S. REIT shares. And that could provoke more sales in following months as the Japanese funds sought to continue the dividend payouts.

Such sales would also lead to falling net-asset values for the Japanese funds. Although Japanese investors view these as annuity-like products and presumably understand a decline could occur, there is the risk some get spooked and pull money out, lowering net-asset values further and potentially provoking more sales.

None of this would be much of a concern to U.S. investors if the Japanese funds' holdings weren't substantial. At last count, Japan's top 10 U.S. and global REIT funds owned 8.6% of mall and shopping-center owner Simon Property Group, SPG -1.85%according to FactSet. They owned 10.1% of Vornado Realty Trust VNO -2.06% .

It's easy to imagine a future where REITs get rocky.

Write to Justin Lahart at [email protected]

A version of this article appeared April 15, 2013, on page C8 in the U.S. edition of The Wall Street Journal, with the headline: Yen for Yield Is a Risk for REITs.

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