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Can REITs Continue to Outperform?

By: Richard Feldman

By: Richard Feldman, CFP, AIF, MBA

Real Estate Investment Trusts (REIT) have been one of the best performing asset classes over the last two years and have outperformed the S&P 500 over the past five years. REITs returned more than 30% on average last year and have had an annualized return of 22.57% as measured by the Wilshire REIT Index over the past five years whereas the S&P 500 has return -2.30%annualized over the same time period. With such dramatic out performance money has flowed into Real Estate Investment Trusts leaving many investors to wonder if they missed the boat or if they own REITs, now may be a good time to reduce their allocation.

What is a REIT?

A Real Estate Investment Trust (REIT) is a company that owns, and in most cases, operates income producing real estate. Some REITs finance real estate as well. To be a REIT, a company must distribute at least 90% of its taxable income to shareholders annually in the form of dividends.

The REIT industry offers investors many alternatives across a broad range of specific real estate subsectors: (Apartment Communities, Office Properties, Shopping Centers and Malls, Storage Centers, Industrial Parks and Warehouses, Lodging Facilities, Health Care Facilities, and Natural Resources).

There are many ways to invest in Real Estate. You can buy investment property outright and act as a landlord, you can purchase individual REIT securities that are traded on national stock exchanges, Real Estate Investment Trust mutual funds (Index or Active), Real Estate closed end funds, or Real Estate ETFs. Most mutual funds or ETFs seek to replicate the performance of various composite indexes such as the Wilshire REIT Index, Morgan Stanley REIT Index, or National Association of Real Estate Investment Trusts (NAREIT). These indexes have put together a composite of the leading Real Estate Investment Stocks based on various criteria. Purchasing Real Estate through a mutual fund or ETF structure provides an efficient way to diversify your Real Estate holdings across geography and property type.

Market Capitalization

Congress created REITs in 1960 to give anyone and everyone the ability to invest in large scale commercial properties. The REIT industry has grown dramatically in size and importance during the last decade. Currently there are approximately 180 publicly traded REITs in the U.S. today, with assets totaling $375 Billion.

Return Factors

Real Estate Investment Trusts have capitalized on the historically low yields on fixed income securities and equity dividends. Because REITs have to pay out 90% of their income to shareholders, investors have typically realized approximately four times higher yields than a typical equity. REITs have also provided an alternative to fixed income securities that are trading at historically low yields.

REITs are very sensitive to interest rates for two reasons. First, the underlying real-estate held in REIT portfolios can be highly leveraged. In order to reduce interest rate risk investors can select REITs with low amounts of leverage. Second, as U.S interest rates rise, government bonds become more competitive with dividends paid by real estate funds.

Historical Returns

(January 1978 to December 2004)

S&P 500 Indez Wilshire REIT Index
Annualized Return 13.44 14.49
Total Return 2913 3759
Growth of $1 30.13 38.59
Annual Standard Deviation 15.78 16.78
Annual
Average