Real estate investment trusts
THE INVESTMENT CASE
The primary investment case for REITs is access to the property market without the liquidity issues that can come with investing in physical property. In addition, REITs have delivered a steady income stream through a variety of market conditions. As a result, the total returns (market returns plus income) for REITs have proven competitive with other asset classes over most periods during the past 45 years. Historically, the long-term total returns from REITs have tended to be similar to the returns from value stocks and higher than the returns from bonds, making them an attractive diversifier in a multi-asset portfolio.
REITs offer the benefits of real estate ownership without the administrative burden or expense of being a landlord. And they are readily accessible: anyone can buy shares in a publicly traded REIT.
Within a multi-asset portfolio, using REITs as a property component offers better liquidity than physical property, and REITs are far less likely to be affected by temporary suspensions during difficult times for property assets. They are also likely to spread their investments across more properties than ‘bricks and mortar’ funds, so offer diversification as well.
Most REITs operate in a fairly simple way: they generate income by leasing space and collecting rent, then pay this income out to shareholders as dividends. It’s worth noting though that managing REITs is not a simple process: to maximise shareholder value, REITs depend on securing tenants, earning rental income and managing complex property portfolios through the ups and downs of the property and wider markets.
Investors should be aware that REITs can be negatively affected by rising interest rates, because this would normally make Gilts and other government bonds more attractive, potentially drawing investment away from REITs and lowering their prices. REITs have to pay property taxes, which can make up a large proportion of their operating costs: if such taxes are increased, this can significantly affect a REIT’s income and thus the returns to investors.
HOW REITs FARED IN CURRENT MARKET TURMOIL
The COVID-19 market turmoil had a severe impact on every major asset type in 2020, and REITs were no exception. The US REIT sector average total return fell by nearly 29% in March, underperforming the NASDAQ, S&P 500 and Dow Jones Industrial Average.
In previous downturns, REITs have been seen as attractive defensive options because investors have been reassured that REITs’ properties will continue to function and will in time grow in value. Of course, in the COVID-19 crisis, hotels, shopping centres and entertainment venues are largely shut down, and important income streams have dried up in the short-to-medium term. Over the long term, however, REITs have a sound long-term investment record and strong diversification credentials.
OUTLOOK FOR REITs
As the world begins to emerge from lockdown, REITs stand to benefit from a regime of low interest rates, and could recover more quickly than some other assets.
More importantly, the fundamentals have not changed: REITs offer an alternative and effective way to invest in property, with levels of liquidity and income that are not always matched by other property investments. They have a strong track record, and offer low correlation and diversification benefits that are crucial when optimising asset allocations and improving potential returns.