It’s easy to fall in love with REITs. What’s not to like about stocks that produced a 28.03 percent total return and a 3.56 percent dividend yield at year-end 2014?
According to data from the National Association of Real Estate Investment Trusts (NAREIT), equity REITs have consistently outperformed the S&P 500 Index.
“The compound annual total returns of the FTSE NAREIT All Equity REITs Index have outperformed those of the S&P 500 for the past one-, five-, 10-, 15-, 20-, 25-, 35- and 40-year periods ending December 31, 2014,” notes NAREIT president and CEO Steven Wechsler.
Apartment REITs had a banner year in 2014, registering a total return of 39.6 percent, fueled by limited new construction and rising demand from an improving economy and job market. Other REIT sectors delivered outsized returns as well: healthcare (33.3 percent), hospitality (32.5 percent) self-storage (31.4 percent), retail (27.6 percent), office (25.9 percent) and industrial (21.0 percent).
With economic and property fundamentals expected to improve in 2015, the outlook for REITs remains positive. Low interest rates and available financing, and increasing domestic and international property investment activity, also support the rosy outlook.
Some bears point to the prospect of rising interest rates as a potential deterrent to REIT performance because it would increase their cost of capital. However, a report from Cohen & Steers notes: “REITs have generated an average annual return of 11.4 percent over the six monetary tightening cycles that have occurred since 1979. Over the seven periods in this timeframe when U.S. Treasury yields were rising, REITs generated an average annual return of 14.9 percent.”
It is true that REITs have delivered impressive long-term performance numbers. However, it is also true that, over a short-term hold, REITs can break your heart. The Dow Jones Wilshire REIT Index, for example, fell 17.6 percent in 2007 and another 39.2 percent in 2008, losing half of its value in just two years. The real estate asset class, in general, is not suited to short-term investment moves. However, over the long term, real estate investments can provide attractive risk-adjusted returns. While REITs can sometimes play a starring role in your portfolio, investors should keep in mind the foremost reasons for including REITs in a diversified, multi-asset portfolio: They reduce volatility, increase diversification and provide a source of income.