Equity REITs: Is There Room for Real Estate in Your Portfolio?
An equity real estate investment trust (REIT) uses the combined capital of many shareholders to buy and operate residential, commercial, and industrial income properties. Equity REITs of all stripes are listed on the major indexes and traded like stocks, so investors may receive a stable income derived mostly from real estate rents without having to finance and manage properties on their own. However, REIT share prices can be volatile and are sensitive to changes in interest rates.
You can buy shares in individual REITs, just as you might buy shares in any publicly traded company, or you can invest through mutual funds or exchange-traded funds. The option to invest in a REIT fund may also be available in your tax-deferred workplace retirement plan. In 2023, it’s estimated that 50% of American households were invested in REITs through one or more of these channels.1
Income and diversification
A REIT must pay out at least 90% of its taxable income each year as shareholder dividends. And unlike many companies, REITs generally do not retain earnings, which is why they may provide higher yields than many other types of equity investments. In 2023, equity REITs yielded 3.9%, on average, compared with 1.4% for stocks in the broader S&P 500 Index.2
The real estate industry’s business model and distinct property markets offer a risk-return profile that differs from the other stock market sectors. In some respects, REITs are a unique asset class, and because their share prices do not always follow the movements of stocks or bonds, they can be a helpful tool to broaden asset allocation and increase diversification. Over the 10-year period ending in 2023, equity REITs had a 76% correlation with the S&P 500 and 56% correlation with the corporate and government bond market. Correlations are even lower over 30 years.3 (Diversification and asset allocation are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss.)
Performance Match-up: REITs vs. Stocks
Source: National Association of Real Estate Investment Trusts, 2024. REITs are represented by the FTSE Nareit All Equity REITs Index. U.S. stocks are represented by the S&P 500 Composite Total Return Index. The performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in an index. Past performance is not a guarantee of future results. Actual results will vary.
Rate-driven volatility
Rising interest rates typically reduce demand and may push down values across property markets, and falling rates tend to have the opposite effect. REITs are directly impacted by the level of interest rates because they depend on debt to acquire rent-producing properties. And in a high-rate environment, REIT dividends tend to be less appealing to investors when bonds are offering similar yields.
For these reasons, REIT shares struggled in 2022 and well into 2023, but prices rebounded near the end of that year after Federal Reserve projections indicated that rates had likely peaked. The return on listed equity REITs was 11.4% in 2023.4
Despite concerns about pockets of distress in the commercial real estate market, the prospects for listed REITs may continue to improve as interest rates settle. As a group, listed REITs entered 2024 with solid balance sheets, healthy debt ratios, and access to capital markets, so they could be in a good position to take advantage of buying opportunities.5
The return and principal value of all investments fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Investments seeking to achieve higher yields also involve a higher degree of risk. There are inherent risks associated with real estate investments that could have an adverse effect on financial performance. These risks may include a deterioration in the economy or local real estate conditions, tenant defaults, property mismanagement, and changes in operating expenses (including insurance costs, energy prices, real estate taxes, and the cost of compliance with laws, regulations, and government policies).
Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
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