– Vatsal Rai
May 24, 2024
Introduction
Real estate has long been a cornerstone of wealth building, providing a reliable means for individuals to accumulate and preserve wealth over time. Owning a property offers a tangible asset that not only appreciates in value but also has the potential for generating steady rental income. This dual benefit of capital growth and income generation makes real estate an attractive investment. However, for many aspiring investors, the significant upfront costs, ongoing management hassles, and the inherent lack of diversification associated with direct property ownership can be daunting obstacles.
This is where Real Estate Investment Trusts (REITs) come into play, offering a compelling alternative that mitigates many of the challenges associated with traditional real estate investments. REITs allow individuals to invest in large-scale, income-producing real estate without the need to directly buy or manage properties. By purchasing shares in a REIT, investors can gain exposure to a diversified portfolio of properties, such as commercial buildings, apartment complexes, and shopping malls. This not only lowers the barrier to entry but also spreads risk across a broader range of assets, making REIT investment a significant aspect of financial planning and enhancing investment values.
Incorporating REITs into your portfolio allows you to benefit from the growth potential of the real estate market while maintaining liquidity similar to that of the stock market. This approach not only diversifies your investments but also aligns with long-term financial planning goals, ultimately contributing to robust and resilient investment values.
What are REITs?
Think of a Real Estate Investment Trust (REIT) as a company that owns, operates, or finances income-producing real estate. These companies pool money from investors and invest it in a diverse portfolio of properties, which can include residential buildings like apartments, commercial spaces such as shopping centers and office buildings, industrial properties like warehouses, as well as specialized facilities such as hospitals, healthcare facilities, and data centers.
One of the key features of REITs is their obligation by law to distribute at least 90% of their taxable income to shareholders in the form of dividends, and to have no more than 50% of its shares held by 5 or fewer individuals during the last half of the taxable year[1]. This requirement ensures that investors receive a steady and reliable stream of income, which is a significant draw for those seeking consistent returns and strong investment values. The dividend distribution mimics the cash flow you might receive from directly owning rental properties but comes without the burdens of property management, tenant issues, and maintenance responsibilities.
Furthermore, REITs offer an accessible way for individuals to invest in real estate, providing liquidity that direct real estate investments lack. They are traded on major stock exchanges, allowing investors to buy and sell shares with ease, thus making real estate investment more flexible and less capital-intensive. This combination of income potential, liquidity, and diversification makes REITs a popular investment vehicle for those looking to benefit from the real estate market without the complexities of property ownership. This is also evident by the fact that 64% of the leading 25 U.S. and international institutional investors have incorporated REITs into their investment portfolio[8], hence emerging as a favored asset class.
Underlying Real Estate Market
Direct ownership of physical property or investment in real estate investment trusts (REITs) offers potential rental income and capital appreciation. In the U.S. market, real estate typically yields a median annual return of 8.6% as per the S&P 500[2]. The strategies employed for investment significantly influence these returns, with various property types appealing to investors pursuing different approaches. On average, residential properties yield 10.6% annually, commercial properties yield 9.5%, and REITs yield 11.8%[2]. The S&P 500 Index’s average annual return over the past two decades is approximately 10%[3]. Regardless of the yardstick used, the real estate industry has performed comparably to the broader market, despite enduring a drastic crisis in housing prices during both the 2008 financial crisis and the 2020 COVID-19 pandemic.
Hence, investors can conveniently achieve diversification in real estate investments by opting for one of the top-performing financial vehicles—REITs.
REITs vs. Stock Market
| TIME PERIOD | S&P 500 (TOTAL ANNUAL RETURN) | FTSE NAREIT ALL EQUITY REITS (TOTAL ANNUAL RETURN) |
| 1972-2023 | 10.2% | 12.7% |
| Past 25 years | 7.6 | 11.4% |
| Past 20 years | 9.7% | 10.4% |
| Past 10 years | 12.0% | 9.5% |
| Past 5 years | 15.7% | 10.3% |
| Past year (2023) | 26.3% | 11.4% |
REITs have outperformed the S&P 500 over the past 20, 25, and 50 years as shown in the above table[4]. However, in more recent years, stocks have shown higher returns, with the S&P 500 surpassing REITs over the past one-, five-, and ten-year periods. Despite this, the long-term data indicates that REITs have generally outperformed stocks.
Dividend payments significantly contribute to the investment returns of both stocks and REITs. For instance, since 1930, 41% of the S&P 500’s total return has been attributed to dividend income[4].
Research by Ned Davis Research and Hartford Funds further analyzed dividends and returns. They found that from 1973 to the end of 2022, S&P 500 companies that paid dividends outperformed non-payers significantly, with an average annual total return of 9.2% compared to -0.6%. Additionally, the research showed that companies that increased their dividends performed better than those with unchanged dividend policies, achieving returns of 10.2% versus 6.6%. Meanwhile, companies that cut or eliminated dividends had poor returns, averaging just 3.95%[4].
The chart below illustrates the average annualized rolling ten-year returns for REITs and the Russell 3000 for each month from January 2000 to October 2020. In more recent times, REITs have consistently outperformed the broader stock market, including during the Great Financial Crisis. This outperformance is partly due to inflated non-REIT returns in the early 2000s, driven by the tech bubble, which gives the Russell 3000 a higher starting point for its ten-year returns. Notably, the chart highlights the lower variability of REIT ten-year returns. The standard deviation for ten-year returns is 9.0% for REITs, compared to 16.0% for U.S. stocks, as shown in Chart 1[5].
When examining average annualized returns for REITs since the early 1990s, it becomes evident that REITs tend to perform better compared to the broader U.S. stock market over longer time periods. Chart 3 illustrates the percentage of months during which REITs outperformed U.S. stocks, with the advantage growing as the holding period increases. Analyzing annual returns, REITs surpassed U.S. stocks more than 56% of the time.
Chart 1 – REITS vs. Stocks
Steady Income Stream
One of the most appealing aspects of US REITs is their capacity to provide a steady and predictable source of income. As noted earlier, US REITs are required to distribute a substantial portion of their earnings as dividends. This results in a consistent cash flow for investors, serving as a reliable income source that can be especially beneficial for US retirees or individuals looking to enhance their existing income stream. Unlike wages or salaries, which can vary or decrease, dividend income from US REITs offers a degree of stability and predictability that is vital for financial planning, particularly in the context of US retirement strategies. Presently, American REITs control over $4 trillion worth of real estate assets, with public REITs alone managing $2.5 trillion in assets[9]. The combined equity market capitalization of listed REITs in the United States exceeds $1.2 trillion[9]. In 2022, REITs distributed an estimated $109.9 billion in dividends to their shareholders[9] hence playing a crucial role in bolstering the economy by directing capital into the markets and enhancing transparency, liquidity, and stability.
Diversification Within the US Market
When constructing a resilient investment portfolio tailored to the dynamics of the US market, diversification stands as a cornerstone principle. Integrating exposure to US real estate into your investment array can serve as a potent strategy to mitigate risk and foster a more harmonized portfolio within the domestic market landscape, enhancing overall investment values.
Traditionally, the quintessential components of most US investment approaches have been stocks and bonds. Yet, these asset classes often demonstrate a tendency to move in concert with the broader US market trends. In contrast, US Real Estate Investment Trusts (REITs) present a distinct advantage with their lower correlation to US stocks and bonds. This divergence implies that during episodes of market turbulence or downturns, US REITs may exhibit distinct performance characteristics, potentially providing a buffer against losses witnessed in other sectors of your US-centric investment portfolio.
Over the last two decades, REITs have shown a moderate performance correlation with the broader equity market, standing at 0.56 correlation, and minimal correlation with investment-grade bonds, at 0.16 correlation[7]. These correlations are noteworthy as they highlight REITs’ tendency to move somewhat independently from both stocks and bonds, which are often considered essential components of a well-diversified investment portfolio.
Hence, incorporating US REITs into your investment strategy fosters a more comprehensive approach, lessening vulnerability to the ebbs and flows of the US market. By diversifying your holdings to include US real estate through REIT investment, you not only spread risk but also tap into an asset class that operates with its own unique market dynamics, thus fortifying your portfolio’s resilience against market volatility.
Accessibility for All US Investors
In contrast to the conventional approach of directly owning physical property in the United States, investing in US REITs presents a notably more accessible avenue to tap into the US real estate market. Unlike the substantial initial investments required for purchasing US properties outright, US REITs offer entry with significantly smaller capital commitments. These trusts, typically traded on major US stock exchanges like any other domestic stock, provide investors with the flexibility to buy and sell shares with relative ease. This accessibility is particularly advantageous as it circumvents the need for hefty down payments, closing costs, and the intricacies of property transactions inherent in traditional real estate ownership. By sidestepping these barriers, US REITs open the door to real estate investment for a broader spectrum of investors, regardless of their financial means or experience level.
In essence, US REITs democratize access to US real estate investment, offering a feasible avenue for a wider range of investors to participate in the lucrative US real estate market, thereby diversifying their portfolios and potentially enhancing their financial returns.
Two Major Types
In the realm of US REITs, investors encounter two primary categories, each presenting unique benefits:
Equity REITs: These entities hold ownership stakes in income-generating real estate properties across the United States. Their revenue streams derive from rental income collected from tenants and any potential appreciation in property values. Equity REITs offer investors a balanced blend of consistent dividend payouts and the opportunity for capital appreciation linked to the performance of the US real estate sector.
Mortgage REITs (mREITs): Diverging from direct property ownership, mREITs channel their investments into mortgages and other debt instruments associated with US real estate. Their earnings stem primarily from interest payments made on these loans. While mREITs can present enticing prospects for investors seeking enhanced yields, they also exhibit heightened sensitivity to fluctuations in US interest rates, a factor that warrants careful consideration.
Exploring these distinct avenues within the US REIT landscape provides investors with diverse opportunities to tailor their portfolios according to their financial objectives and risk tolerances.
Sortis REIT: The Sortis Advantage
Sortis REIT stands out for several key reasons. It’s tailored for Accredited Investors, requiring a minimum investment of $25,000. Investors enjoy quarterly distributions, providing a steady income stream. Redemption is possible after 6 months, with caps of 2% quarterly and 5% annually, subject to fund availability and advisor discretion. The REIT’s impressive maximum offering is set at $1 billion, showcasing its scale and potential. Management charges are transparent at 1.25% of Net Asset Value (NAV), with a profit-sharing mechanism ensuring further transparency[6].
Sortis REIT focuses on acquiring stabilized or readily stabilized real estate assets, prioritizing off-market transactions. Deal sizes range from $2 million to $20 million to stay competitive[6]. Supported by Sortis Holdings, Inc., they enhance acquisitions through curated retail experiences. Asset classes include multifamily, hotel, retail, office, light industrial, and life science properties.
The REIT’s approach, led by individuals with proven investment management expertise, identifies opportunities for strong risk-adjusted returns. Focused on the Western States, they capitalize on localized expertise. As a boutique-sized fund, Sortis REIT maintains flexibility in the market, avoiding forced investments. Their diverse relationships facilitate unique access to deals, and staff members’ personal investments align their interests with investors[6].
Conclusion
In conclusion, Real Estate Investment Trusts (REITs) present a compelling opportunity for investors seeking to capitalize on the benefits of real estate ownership without the traditional drawbacks. By pooling capital and investing in a diversified portfolio of income-generating properties, REITs offer a unique blend of steady income streams, capital appreciation potential, and liquidity that is unmatched by direct property investment.
The historical performance data speaks volumes about the resilience and profitability of REITs, outperforming the stock market over extended periods while exhibiting lower volatility. This track record, coupled with the inherent diversification advantages that REITs provide, solidifies their position as a valuable addition to any well-rounded investment portfolio. Moreover, the accessibility of REITs, facilitated by their listing on major exchanges, democratizes real estate investment, enabling individuals of varying financial means to tap into the lucrative real estate market. This democratization not only empowers investors but also fosters a more inclusive and transparent financial planning process.
As the demand for real estate continues to grow, driven by factors such as population growth, urbanization, and evolving lifestyle preferences, the prospects for REITs remain promising. Innovative offerings like the Sortis REIT further enhance the appeal of this investment vehicle, leveraging specialized expertise, strategic acquisitions, and alignment with investor interests.
In an ever-changing financial landscape, the case for REIT investment remains compelling. By embracing the unique advantages they offer, investors can position themselves to reap the rewards of real estate ownership while mitigating many of the associated risks and challenges. As such, REITs emerge as a valuable cornerstone for any well-diversified, income-generating investment strategy, enhancing overall investment values.
References
[1] “Investor Bulletin: Real Estate Investment Trusts (REITs).” n.d. https://www.sec.gov/files/reits.pdf.
[2] “What Is Real Estate Return on Investment (ROI)? – Forbes Advisor.” n.d. Www.forbes.com. https://www.forbes.com/advisor/investing/roi-on-real-estate-investment/.
[3] “The Average Annual Return for a Long Term Investment in the Real Estate Sector.” 2019. Investopedia. 2019. https://www.investopedia.com/ask/answers/060415/what-average-annual-return-typical-long-term-investment-real-estate-sector.asp.
[4] DiLallo, Matthew. 2020. “REITs vs. Stocks: What Does the Data Say?” The Motley Fool. August 5, 2020. https://www.fool.com/research/reits-vs-stocks/.
[5] “REIT Average & Historical Returns vs. U.S. Stocks.” n.d. Www.reit.com. https://www.reit.com/news/blog/market-commentary/reit-average–historical-returns-vs-us-stocks.
[6] “Sortis REIT.” n.d. Sortis Capital. Accessed May 21, 2024. https://sortis.com/reit/.
[7] Buller, Steven, Sam Wald, and Andy Rubin. n.d. “Leadership Series REIT Stocks: An Underutilized Portfolio Diversifier AUTHORS.” Accessed May 21, 2024. https://www.reit.com/sites/default/files/media/PDFs/Research/REITStocksAnUnderutilizedPortfolioDiversifier_Fidelity.PDF.
[8] “REITs Statistics: Key Trends in 2024.” 2023. Www.doorloop.com. September 28, 2023. https://www.doorloop.com/blog/reits-statistics#:~:text=64%25%20of%20the%20top%2025.
[9] “REITs by the Numbers.” n.d. Www.reit.com. https://www.reit.com/data-research/data/reits-numbers#:~:text=U.S.%20listed%20REITs%20have%20an.