Over most extended time periods, say 10 years or longer, REIT returns have been equal to or better than those of equities. For instance, during the 10 years to June 30, 2016, the S&P Global REIT Index returned 6% annualized, compared to just 2.1% for the MSCI EAFE Index of developed-country equities and 7.4% for the S&P 500 Index. But the way REITs and equities generate those returns is quite different, with the lion’s share of equity returns coming from capital appreciation and the bulk of REIT returns stemming from dividends (REITs are required to distribute at least 90% of taxable income—the source of those dividends–to shareholders each year). As an asset manager with a high degree of tax awareness, by the way, this fact is key to my frequent recommendation that many investors have distinct and targeted real estate exposure, so that they may own their REITs more heavily within retirement or other tax-advantaged accounts.
Indeed, this hybrid asset class—with bond-like yields and stock-like appreciation potential—offers nice portfolio diversification due to relatively low correlations with other major asset classes. From January 1, 1990 to June 30, 2016, global real estate’s correlation with US and international equities was about 0.6; with US and international bonds (as measured by the US Aggregate Bond Index and Citigroup WGBI 1-5 Year ex US) the correlations were only 0.22 and 0.25, respectively.
I earlier indicated my preference for global—as opposed to US-only—REITs, since international REITs provide exposure to geographic and economic environments ranging from London to Singapore to Sydney. We have conducted a considerable amount of research on how adding 5% to 15% REIT allocations to various equity and equity/fixed income portfolios impacts portfolio returns and volatility. We found that, for instance, adding a helping of REITs (perhaps 5% to 15% of the total portfolio) to all-equity or 80 equity/20 fixed income portfolios produced better risk-adjusted returns. I invite you to read our research paper on this topic, “Investment Insights: Taking a Global Approach to Investing in Public Real Estate.”
REITs And Rates
Finally, I would like to address the link between REITs, inflation, and interest rates. One benefit of REITs is that they can act as a strong hedge against inflation. Historically, REIT yields have been higher than the inflation rate, as measured by the Consumer Price Index (CPI), and over most extended periods—in stark contrast with fixed-income securities—the income stream from REITs has increased at a higher rate than CPI. Keep in mind that lease agreements for commercial property typically have clauses that build in inflation adjustments for rental payments based on the CPI or some other inflation index during the lease period.