A real estate investment trust (“REIT”) is a company that owns, operates or finances income-producing real estate across a range of property sectors. REITs provide an investment opportunity for everyday Americans—not just Wall Street, banks, and hedge funds—to benefit from valuable real estate, access dividend-based income and total returns, and help communities grow, thrive, and revitalize.
REITs allow anyone to invest in portfolios of real estate assets the same way they invest in other industries – through the purchase of individual company stock or through a mutual fund or exchange traded fund (ETF). The stockholders of a REIT earn a share of the income produced – without having to go out and buy, manage or finance property.
REITs historically have delivered competitive total returns based on high, steady dividend income and long-term capital appreciation. Their comparatively low correlation with other assets also makes them an excellent portfolio diversifier that can help reduce overall portfolio risk. Over the past few decades, assets have become increasingly correlated. This has challenged investors to identify investments to diversify their portfolios. Fortunately, REITs provide access to meaningful diversification opportunities.
REITs are total return investments with the potential for moderate, long-term capital appreciation. Long-term total returns of REIT stocks tend to look like those of value stocks and yield more than the returns of lower risk bonds. From 2004 through 2021, equity REITs averaged 11.88% return and now yield 2.8% - over twice that of the S&P 500.
Because of the strong dividend income REITs provide, they are an important investment both for retirement savers and for retirees who require a continuing income stream to meet their living expenses. REITs dividends are substantial because they are required to distribute at least 90 percent of their taxable income to their shareholders annually. Their dividends are fueled by the stable stream of contractual rents paid by the tenants of their properties. The relatively low correlation of listed REIT stock returns with the returns of other equities and fixed-income investments also makes REITs a good portfolio diversifier. REIT returns tend to “zig” when those of other investments “zag,” helping to reduce a portfolio’s overall volatility and improve its returns for a given level of risk.
After posting initial declines early in the pandemic, REIT share prices have recovered as the real estate sector has proven to be resilient. REIT sectors that support the digital economy—data centers, infrastructure, and industrial REITs—rebounded most rapidly in the summer of 2020 as online communications and e-commerce purchases replaced in-person interactions during the period of most stringent social distancing requirements. Other sectors recovered more fully after vaccines against COVID-19 were introduced in November 2020.
Some sectors remain below pre-pandemic levels, including lodging/resorts, office, diversified, and health care REITs. Other sectors, however, have had double-digit returns. Some sectors have delivered exceptional returns, including industrial REITs, with total returns of 57% through November 2021, and self-storage REITs—which have had a surge of demand due to strong housing markets and home sales, plus additional need for space during the pandemic—with investment returns exceeding 70%.
Overall, the year ahead is likely to build on the recovery that is already underway in the macroeconomy and in commercial real estate markets. REITs are likely to perform well in this growth environment.
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Brad Lyons, CFP®