Should you invest in a Real Estate Investment Trust (REITs)? This is a question for people who are both looking to start investing and those who may already be invested in equities. Real estate is a great way we can diversify; especially if you are heavily invested in stocks. Everyone knows that diversification is a fantastic way to spread out risk. Commercial real estate is also presenting some interesting investment opportunities right now.
If you are heavily invested in something like a Global Equity Index Fund (e.g. Vanguard FTSE All Cap Index Fund) you might be asking yourself if there is any point to investing in a real estate trust. This is because to some extent your index fund may capture the large-cap real estate stocks.
Disclaimer: This article should not be considered as financial advice. You are responsible for your own financial research and decisions.
Should You Invest In A Real Estate Investment Trust?
Understanding REITs and how weighted property should be in my portfolio is a question I asked myself at multiple points in recent years. Which leads to further questions such as:
How to invest in a real estate investment trust?
Can REITs be tax efficient (e.g. held within an ISA)?
What are the best Real Estate Investment Trusts?
Should I invest in a fund with a higher weighting of real estate stocks?
How invested should I be in real estate right now?
You might not be invested in a Global Equity Index fund but are keen to invest in real estate in general. However, you might not fancy or can’t afford an investment property, Obviously, it’s challenging enough owning one property in this housing market, never mind buying a second.
If you don’t want the risk putting all your eggs in one basket (e.g. buy to let) or actively manage a real estate portfolio, then a Real Estate Investment Trust might be a good solution.
What Are Real Estate Investment Trusts?
Real Estate Investment Trusts (REITs) are a great way of owning a small piece of the real estate pie. This is because you can buy into multiple real estate stocks.
There is no doubt that real estate stocks provided a fantastic buying opportunity this year, especially commercial real estate stocks as the prices suffered a shock in 2020.
REITs are companies that own (and often operate) income-producing real estate, such as apartments, warehouses, self-storage facilities, shopping centers and hotels.In fact, there are three main types of REIT:
Equity REITs own and manage income-producing real estate. Revenues are generated primarily through rents (not by reselling properties).
Mortgage REITs lend money to real estate owners and operators either directly through mortgages and loans, or indirectly through the acquisition of mortgage-backed securities.
Hybrid REITs. These REITs use the investment strategies of both equity and mortgage REITs.
These three types of REIT can be separated by their investment holdings; equity, mortgage and hybrid. Which can be purchased through publicly traded REITs, non traded REITs and private REITS.
#1 Real Estate Investment Trusts Have Outperformed Stocks
Personally the big question for me is actually whether or not REITs are a better long-term investment than either stocks.
According to MillionAcres, the answer is yes. In fact, REITs have actually outperformed the S&P 500 over the long term. I am probably as surprised by you as this! I never considered that it might be better to invest in a real estate trust over equities.
The FTSE Nareit All Equity REITs Index has beaten the S&P 500 in 15 of the last 25 full years. Over those 25 years, the annualized total return of that equity REIT index has been 10.9% — that’s a total return of about 1,225% during that time.
What’s more is that This is more than double the average 1.83% dividend yield among stocks in the S&P 500. You can see the dividend by subsector below.
Are REIT Dividends Too Good?
One of the most favourable factors of real estate trusts is that they have a very strong track record for paying large dividends, to the extent where one Reddit user voiced concerns that it could potentially harm their growth. This is because in order to qualify as a REIT, a company must comply with certain provisions
Invest at least 75% of total assets in real estate, cash, or U.S. Treasuries
Derive at least 75% of gross income from rents, interest on mortgages that finance real property, or real estate sales
Pay a minimum of 90% of taxable income in the form of shareholder dividends each year.
Be an entity that’s taxable as a corporation.
Be managed by a board of directors or trustees.
Have at least 100 shareholders after its first year of existence.
Have no more than 50% of its shares held by five or fewer individuals.
Whilst dividends are great for many investors, those seeking growth may be a little put off that a business is paying out 90% of taxable income to shareholders as it may restrict growth.
#2 There Are Fantastic Growth Opportunities For Equity REITs
There have also been some pandemic associated buying opportunities. These have resulted due to the disproportionate effects of economic shutdowns on commercial real estate.
Which you can read about in one of my previous articles: Cryptocurrency vs Stocks vs Real Estate: Where Is The Opportunity Right Now?
Opportunities have also arisen from the post-pandemic shift in working behaviour towards hybrid work environments. I live and work in Leeds and I’ve been seeing a good run of articles on new co-working spaces such as Spacemade.
There are also some high-profile companies such as IWG reporting a boom in hybrid working. Revenues from hiring of meeting rooms and day offices up by 40% as businesses adopt home-office split. In fact, it recently added two more locations to it’s Manhattan portfolio.
Real Estate Weighting In Stock Portfolios
When I saw the prices of some of the REITs, I had to ask if they they represented enough in my large-cap dominated stock portfolio. Did I need to invest in a seperate real estate investment trust to gain more exposure to property; more than is otherwise represented in the index?
As it turns out, my fund actually consists of 9.1% (previously it has been closer to 13%. ) into a REIT called iShares Glb Prpty Secs Eq Idx (UK) L Acc. This fundtracks the FTSE NAREIT. The NAREIT is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs.
By contrast Vanguards Global Equity Fund has around a 6.5% allocation into Real Estate, whereas the FTSE All Cap Index Fund is more watered down at 3.5%. So the big question is do you want to be more exposed to real estate, knowing the average performance we described earlier.
#3 Real Estate Investment Trusts Can Diversity Your Portfolio
One of the most common investing questions is “Should I Invest In A Real Estate Trust (REIT) If I Hold A Global Equity Index Fund?” There are a lot of considerations for diverging from your index fund based portfolio (if you have one already, if not check out my series on beginner investing).
For example, if you are going to buy into an REIT outside of your S&S ISA then you need to know the space around taxes (e.g. Dividend taxation). There are some ISA ready REITs which include but are not limited to the iShares funds:
One aspect to also consider is that you may also be exposing yourself to higher overall fees. This is something to consider when diverging from a broad index based approach to investing. For example, the ASI Global Real Estate Fund has an ongoing charge of 1.23%, a far cry from the cost of an index tracker. Although the iShares UK Property is significantly lower at 0.4%.
Why Reinvesting Your Dividends Is Key
It’s crucial to know if you can reinvest dividends to take advantage of compound interest. Compound interest refers to the principle that when you save money, as well as earning interest on the savings, you also earn interest on the interest itself.As a result it has a multiplying effect over time.
The iShares Glb Prpty Secs Eq Idx (UK) L Acc is an accumulation fund and will therefore reinvest the dividends. However, many REITs will likely be income funds due to the high dividend we discussed earlier. Ultimately, if you can diversify your portfolio in a low cost method, then based on the historical averages you can potentially improve your returns. However, this is never guaranteed.
Conclusion: Should You Invest In An REIT?
Real Estate Trusts are worth considering with regards to both dividends and growth prospects. As we can see they have historically performed strongly, even when compared to the likes of the S&P 500.
There is also the consideration of diversifying your investment portfolio. I always like to evaluate worst case scenarios. For example, what happens to stocks that are highly weighted in benchmark indices such as the S&P struggle over a long-period of time (see, Japanese Nikkei Asset Bubble).
Obviously, I won’t be abandoning my global equity index fund and I can’t imagine changing my asset allocation in any major way. However, I do always consider how much I should be diversified across asset types. REITs are a potential option in this respect.
Therefore, I’ll be giving careful consideration to how much my fund is weighted towards Real Estate Trusts. I am comfortable with an allocation around the 10% mark. For now this a reasonable weighting, but as I move closer to financial independence, this may change.
What’s your allocation to real estate and what do you think it should be? Will this change the closer to financial freedom you get?
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