A REIT is simply a FIRM that owns or finances income-producing real estate. Many REITs are traded on major stock exchanges or private equity and investors can purchase a share of the REIT just as they would any other stock. One major draw of REITs is that they provide investors with regular income, as they normally pay out their taxable income as dividends to shareholders.
In the low interest-rate environment that has prevailed in recent years, income investors have turned to REITs to generate potentially higher rates of return than more traditional income-generating investments, such as Treasury bills or certificates of deposit. In 2014, the FTSE NAREIT All Equity REITs Index gained an eye-popping 28 percent. But through May 28 2014, the index had a dip downwards of 0.32 percent, erasing an 8.8 percent gain earlier in January 2014.
“REITs are about the only game in town if you are looking for strong yield,” says Brad Case, senior vice president at the National Association of Real Estate Investment Trusts a major industry association group.
Even compared with stocks, the dividend yield for equity REITs is favorable at 3.61 percent, versus a 2 percent dividend yield on the Standard & Poor’s 500 index through April 30.
Here are three reasons to consider adding REITs to your portfolio.
1) REITs typically perform well when interest rates are going up. “With bonds, when interest rates go up, bond values go down. But for REITs, when interest rates go up because the economy is strengthening, you have higher rent growth and higher occupancy rates, which means higher income from buying real estate,” Case says.
Looking back over the previous 16 periods of rising interest rates, Case notes that REIT returns were “positive in 12 of those periods and strongly positive in nine of 12.” He highlights the June 2005-June 2006 period as a time when interest rates were rising in response to a growing economy. From June 2, 2005, to June 26, 2006, 10-year Treasury yields climbed from 3.89 percent to 5.25 percent, while REITs gained 20.7 percent during that period.
2) REITs complement a well-diversified portfolio. “Long-term investors seeking to construct and maintain a well-diversified portfolio should invest in REITs to gain exposure to an important asset class that is otherwise difficult to access,” says Michael Knott, managing director of Green Street Advisors, a Newport Beach, California, real estate research and advisory firm. “REITs are the best way to achieve real estate-like returns and the benefits of diversification to one’s portfolio.”
For investors who don’t have exposure to real estate, now may be a good time to consider adding an allocation, Knott says. He recommends a target of 5 percent to 15 percent for most investors.
“Despite the recent volatility, REIT valuations are more attractive than earlier in the year,” wrote Mark Litzerman, co-head of real estate strategy at Wells Fargo Investment Institute in a May research report. “Investors may want to consider taking advantage of potential opportunities to add to underweighted portfolios.”
3) REITs follow a different business cycle. Real estate moves in a different cycle than other industries, and the current cycle for real estate shows there is still some room to run. “Because of the long amount of time it takes to build and lease out commercial properties, the commercial real estate cycle is approximately 18 years from trough to peak – about four times as long as the general business cycle. We’re currently nine years into the current cycle. So, it’s still middle innings for real estate investors,” Case says.
For stock investors, these picks stem from Green Street Advisors’ three favorite property types for long-term investors: malls, apartments and self-storage. Each of these property sectors has a strong track record and a relatively low capital expenditure burden, Knott says.
Taubman (symbol: TCO). This REIT has a proven record in the mall business, along with a management team led by a founding family with a large stake and a long-term vision, Knott says. He calls it a “high-quality portfolio that currently trades at a meaningful 25 percent discount to the value of its real estate.” The stock, which recently traded at $75, has traded between $71.43 and $85.26 over the past 52 weeks.
Equity Residential (EQR). This is a best-in-class apartment operator that owns a high-quality portfolio located in coastal markets that should be longer-term winners, Knott says. The company has a strong track record and trades below the value of its real estate, he adds. The stock, which recently traded at $75, has a 52-week range of $60.44 to $82.53.
Public Storage (PSA). This REIT is the leading player in a strong but unsexy niche. Self-storage is very attractive to investors because of its impressive growth and low capital expenditure requirements, Knott explains. “The management has delivered impressive long-term returns without taking a lot of risk, and the company is more attractively valued than its closest competitor, Extra Space, which is also an immensely talented company. Self-storage trades at premiums to the private value of the real estate, but that’s because the private market values the business too cheaply. The public market is much closer to right, but even then, is not bullish enough,” Knott says. The stock has a 52-week range of $162.34 to $206.92 and recently traded at $196.