For investors, there are two main ways to include real estate in their portfolios: Real-estate investment trusts (REITs) and direct investment in real estate. While direct ownership in real estate offers far greater control over the investment and its performance, REITs provide exposure to real estate without actually owning property directly.
REITs are companies that hold many investment properties, including multifamily and office buildings, hotels, warehouses and shopping malls. Like other stocks, REITs are traded on the major stock exchanges, and they distribute the bulk of the rent they collect to investors in the form of dividends.
Many REITs specialize in certain types of properties, such as shopping malls (Simon Property Group), apartments (Equity Residential) and self-storage facilities (Public Storage). REITs also own some of the nation’s most well-known properties, giving investors an opportunity to invest in often iconic real estate, such as the Empire State Building (owned by the Empire State Realty Trust).
Another type of REIT is a “mortgage” REIT that invests in the loans behind commercial and residential properties and in mortgage-backed securities, sometimes using leverage in an effort to boost returns.
To the Investors Go Most of the Profits
Unlike other companies, which keep much of their earnings, REITs pay out at least 90% of their taxable profits to investors. Ideally, REIT funds should be held in a tax-advantaged account, such as an individual retirement account or 401(k), to avoid a hefty tax bill.
Even if you not that familiar with REITs, you may already own them because broad U.S. index funds are probably invested in REITs to some degree. However, les than 3% of the S&P 500 is in REITs, according to S&P Dow Jones Indices. By comparison, 13% of gross domestic product could be attributed to real estate, rentals and leasing in 2014, according to the Federal Bureau of Economic Analysis. Most home-building activities fall into a different category.
Investors who are underweight REITs can miss out on the benefits of diversification. In addition, REITs often move in a different direction than stocks or bonds. In the past three decades, REITs’ rolling 36-month correlation with other stocks — a measure of whether their returns move independently of one another — has ranged from 0.89 to negative 0.16. A value of 1.0 means that they moved in perfect sync, while a negative value means stocks rose when REITs fell and vice versa.
At the same time, investors might not want to get their hopes too high in the near term. Investors that recently moved into REITs and other high-dividend investments because of the income they generate may want to proceed cautiously; REITs could be especially susceptible to a pullback as interest rates rise, particularly if the Fed raises rates faster than expected.
However, rising interest rates haven’t meant bad times for REITs in the long run. According to the Gerstein Fisher Multi-Factor Global Real Estate Securities Fund, during the five periods since 1978 when the Fed lifted short-term rates, U.S. REITs returned a monthly average return of 1.28%, compared with 1.21% for U.S. stocks and 0.47% for U.S. bonds. REITs’ monthly returns in falling-rate environments were actually worse — 1.06%, compared with 0.85% for stocks.
We always recommend that our clients consult with their accountant or financial advisor for specifics before investing in REITs or any other investment.
About the Northeast Private Client Group
Northeast Private Client Group is the fastest-growing mid-market investment sales firm in the Northeast, providing unmatched results by combining specialized market intelligence with a relationship-based marketing strategy that caters to clients’ needs. The firm’s collaborative and research-driven solutions are tailored to meet the individual needs of investors and property owners across the Northeast who are looking to buy, sell or exchange mid-market properties, including mixed-use, multifamily, retail and office assets. Northeast Private Client Group’s highly disciplined process is just one of the many reasons the firm has earned the CoStar Power Broker designation year after year. www.northeastpcg.com