Various factors make this a good time to get retail clients into REITs, but convincing them to add this stable portfolio diversifier carries a communications challenge.
Since Labor Day, the NAREIT index had declined about 5 percent by mid-October. But despite after six straight months of positive returns early in the year, REITs were still down 7 percent for the year and 10 percent from the year’s high. This decline is generally attributed to concerns over rising interest rates, which is ironic considering that REITs have usually done well during long periods of rising rates and increasing inflation. In more than half of the 87 historical periods of rising rates, they’ve outperformed the S&P 500. And as more Fed rate increases are projected, outlooks for REITs are positive.
To help clients get their heads around this investment, here are some talking points for answering likely questions:
Just What Is A REIT?
Real estate investment trust is just a fancy name for a company that owns a lot of real estate. In many ways, they’re no different from other types of companies—but there’s an important distinction: Their regulatory status as pass-through entities requires them to pay out 90 percent of their profits in dividends.
There are two basic kinds of REITS—equity and mortgage. Equity REITs own property of various types and lease it out for income, while mortgage REITs buy mortgages using leverage and play the spreads between their rates and borrowing rates. When interest rates rise, these spreads tend to narrow, punishing mortgage REITs. By contrast, relatively low-leverage equity REITs raise rents over time, assuring stable dividends and future increases.
Brad Thomas, editor of Forbes Real Estate Investor, says it’s important to have a look at what kind of leases a particular equity REIT holds: “With companies that have longer-term leases [many commercial leases run for 10 years], it’s much easier to predict future earnings and dividend growth.”
How Would You Contrast REITS With Stocks?
The REIT universe is tiny compared with stocks. There are only 188 REITs in the NAREIT index, and funds represent millions of dollars rather than billions.
If clients feel investing in stocks is like betting the farm, REITs can be more like owning the farm. Since 2015, the Fed has pushed up interest rates, and the REIT index (measuring prices), has recently been at 2015 levels. Yet over those three years, shareholders received income totaling about 6 percent. Sure, the stock market has done well over this period, but the question today is: Do you expect to get 18 percent from the stock market over the next three years? Some REITs’ income can be anticipated about like bonds’.