“If you go back and measure performance over any meaningful time period, you’ll find that REITs have performed quite well compared to other stocks and bonds,” observes Ralph L. Block, author of Investing in REITs: Real Estate Investment Trusts.
Block, who has invested in, written, and spoken about the nuances of REIT investment for several decades, believes investors should not regard REITs as an all-in or all-out portfolio position. Instead, he sees the right REITs as deserving a permanent allocation in most portfolios.
What Makes REITs Right for Portfolios?
According to Block, the key to determining if a specific REIT is right for your portfolio, is its balance sheet. The higher the debt level, the more volatile and riskier you can expect the REIT to be since these securities will be more vulnerable to moves in interest rates and economic weakness. Generally, the more highly leveraged (higher debt) REITs include mortgage REITs and, often, those that make money developing and reselling property. Mortgage REITs also tend to have higher yields to compensate for the increased risk.
But the majority of REITs are not as highly leveraged and offer steadier prospects. These REITs own and operate income-producing real estate, which offers a more reliable income stream even when interest rates are rising. This type of REIT, known as an Equity REIT, makes up roughly 90% of all REITs, according to Block.
What You Need to Know about REITs
Before investing in any REIT, here are a few more things you should consider:
- All REITs are not created equally. The term, “REIT,” refers to the investment vehicle’s structure—like “stock” or “bond.” But each REIT is unique in terms of the types of properties it owns and the business strategies it pursues. Therefore, each may react to economic conditions differently. For instance, a recession might not have as much of an impact on the underlying business (rental and occupancy rates) of healthcare REITs, as it would on office and industrial REITs.
- Real estate prices, especially for commercial real estate, move in cycles. These cycles are related to the economy. But that doesn’t necessarily mean you should trade in and out of REITs based on economic conditions. Many property leases are long-term, which can keep revenue relatively stable.
- Go big. Block suggests that, when it comes to investing in REITs, investors can reduce some of the risk by “going big.” By sticking with the largest REIT operators, an investor can gain access to a much steadier ride, experiencing more of what is right about REIT investing and side-stepping more of the aspects that can go wrong.
- You are not alone. When you decide to invest in individual REITs, you are not exactly fending for yourself. REITs are pools of professionally managed income-generating investment properties. These professionals are experts at identifying properties worthy of long-term commitments. Given the high transaction costs associated with buying and selling real estate, they are focused on minimizing the need for added expenses.
REITs are far from riskless, but they do offer a low correlation to other stocks and also bonds, along with a steady (and often increasing) income stream—factors that have helped make investors like Block life-long holders.