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’. 

What Makes You Think REIT Yields Will Be Good Over The Next Few Years?

Projections of interest rate increases based on economic growth, which will enable tenants to pay higher rents. Also, the forward indicators for REIT yields in relation to Treasury bonds’ are favorable.

Do Large Institutional Investors Own REITs?

Absolutely. Real estate is the third-biggest asset class owned by institutions, and much of this exposure is in the form of REITs. Of course, as they have professional managers tending to their portfolios, institutions have the option of having greater proportionate exposure than individuals, for whom it’s generally advisable to have no more in them than 20 percent—often 10 to 15 percent.

As Residential Real Estate Has Risen So Much Since The Post-Bubble Housing Crisis In 2008, How Could Residential REITs Possibly Be A Good Investment?

Because there’s still plenty of pent-up demand left to fuel real estate growth. The nation needs an estimated 1.5 million new homes of various types annually to meet the demand, but there has been well below that number every year since 2007. Pronounced under-building followed the popping of the housing bubble in 2008, and sales bottomed out in 2013 to 2014. But this started picking up markedly in late 2015/early 2016. The slack in the market has since played out, and there’s now pressure on supply from demand by most demographic groups. Millennials, many of whom have been living with their parents, are getting jobs and apartments in the improving economy. And Gen-Xers with growing families seeking more space in single-family homes.

I’ve Read That REITs Owning Shopping Malls Can Be A Bad Investment These Days Because Online Shopping Is Beating Up Bricks-And-Mortar Retailers. Is This True?

Well, yes and no. It’s true that many shopping malls have been doing poorly, with large anchor stores pulling out, and this has clearly hurt REITs that own these properties. However, this has pushed down the prices of those REITs substantially, creating room for growth in those that own malls where people are still shopping. It’s virtually impossible to avoid mall exposure in REIT ETFs, but not in actively managed funds or in individual REITs. In the latter, investors can carve out desirable niches among the available REITs. Some of these companies are extremely specialized, owning everything from server farms to actual farmland to online retail fulfillment centers and warehouses to data centers, hospitals and cell towers (an area of projected strong growth for companies that already own lots of towers, as the new 5G service requires more towers).

Of course, if you want a diversified individual REIT portfolio, this increases the management burden—from selecting REITs from different sectors, weighting investments in them and managing the resulting portfolio. If this is your goal, it’s a good idea to not be weighted to heavily in any of these specialized REITs. Yet if diversification isn’t a concern and you’re using REITs as a tactical tool to leverage emerging industrial, commercial and residential trends, that’s another matter.

Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC, an equities management firm in Indianapolis. The firm started in 2001 with $60 million in assets. Today, it has AUM of more than $1 billion.