If you watch any TV, you've probably seen the infomercial about making a million in real estate. Google "real estate millionaire," and you'll get more than 7 million hits. And over the past five years, the value of residential property in developed countries has more than doubled, according to The Economist. You know you want a piece of that action.
Unfortunately, real estate is historically no better a sector for investment than any other, and it might be due for a swoon. That means you need to be very careful these days when you're picking real estate investment trusts (REITs) for your portfolio. Many of the current valuations are overblown.
A fantastic run
For the most part, REITs are up significantly since the beginning of 2005. The Vanguard REIT Index Vipers is up 25%, Equity Residential
Moreover, approximately 20% of purchasers in the current market are speculators or multiple-home buyers. These folks are inflating demand, particularly in San Diego, San Francisco, New York City, and Washington, D.C., and making the operating environment more expensive and more difficult for the REITs you know and love.
Recently excluded from the current boom are mortgage REITs, which have been squeezed by rising interest rates and a flattening yield curve. New Century Financial
I don't think the real estate sector is on the verge of collapse, and I continue to hold shares of two REITs: Thornburg Mortgage and American Financial Realty
That's not the best deal. Investors can do better by focusing on companies that control small niches across the country, or do business in places where the premium on real estate is lower .
Foolish final thoughts
Fool dividend guru Mathew Emmert recently identified two small-cap REITs that meet those criteria and offer yields greater than 6%. These select opportunities take a little bit of digging to discover. If you'd like to know where you can get an above-average yield for a below-average price, click here to be our guest at Income Investor free for 30 days.
Real estate exposure is vital to a balanced portfolio. But remember: The best investors never overpay.
This article was originally published on Dec. 15, 2005. It has been updated.