REIT [Post 11]

*This post outlines REITs in comparison to a diversified portfolio of index funds. Why not compare REITs to physical real estate? For an experienced real estate investor, physical property is likely the superior investment as it can produce rental income, capital appreciation, and tax benefits that can all exceed that of REITs. Seek the opinions of a qualified advisor and tax professional prior to the implementation of any investment strategy or buying any security.

What is a REIT? A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate. Many REITs are publicly traded on exchanges, like stocks.(1)

Should REITs be included in an investment portfolio?

For someone that wants to own real estate but doesn’t have the capital or expertise to own physical property, REITs are a solid alternative.

Let’s list the Pros and Cons of including REITs in a diversified portfolio of index funds.

Pros

• REITs can be a good portfolio diversifier as they typically have a low correlation to the stock market.(2)

• If you are seeking cash flow, REIT dividends can provide this feature.

• REITs can provide less volatility than the broad stock market due to steady income flows generated by dividends.

• REITs are a highly liquid way to gain exposure to real estate as you don’t have your money tied up in large deals for long periods of time.

Cons

• REITs are tax inefficient. These companies are required to pay out 90% of their taxable income to shareholders as dividends. These dividends are taxed as ordinary income (at a higher tax rate than capital gains that other exchanged traded investments held for over a year receive).

• Research suggests adding more real estate exposure to a portfolio through REITs, does not improve total returns of traditional stock and bond portfolios.(2)

• Singular REITs hold idiosyncratic risk – meaning company-specific events/market developments or management decisions have a large impact on performance that cannot be diversified away.

• REITs are sensitive to interest rates; real estate activity tends to decrease when it is more expensive to borrow money.

Summary

REITs often do not match the overall return or benefits received by experienced physical real estate investors.

Compared to an indexed portfolio; REITs are tax inefficient, do not provide substantial evidence of better returns, and introduce additional risks.

It is also important to note that real estate likely already makes up 0-5% of most broad indexes. Meaning you may already have exposure to the real estate sector in your portfolio without realizing it.

Regardless, if you insist on owning more real estate in your portfolio, a REIT index is one way to achieve diversified real estate exposure.

(1) Chen, J. (2023, January 12). Real Estate Investment Trust (REIT): How they work and how to invest. Investopedia. https://www.investopedia.com/terms/r/reit.asp

(2) Kizer, Jared and Grover, Sean. (December 6, 2017). Are REITs a Distinct Asset Class? https://ssrn.com/abstract=2965146 or http://dx.doi.org/10.2139/ssrn.2965146