REITs: A Rational Way To Invest In Real Estate?
Chapter 14 of The Rational Investor
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Chapter 14: REITs: A Rational Way To Invest In Real Estate?
In chapter 13, I highlighted three problems with real estate investing:
Lack of diversification.
Large financial and time commitments are required to manage properties.
Lack of liquidity.
What if I told you that you could invest in real estate and diversify over thousands of properties, and you would never have to think about fixing a leaky toilet?
You can do that by investing in Real Estate Investment Trusts (REITs).
Do REITs have a place in the portfolio of a rational investor? Let’s have a look at the evidence.
What is a REIT?
REITs are companies that invest in commercial real estate. REITs invest in a variety of Real Estate projects that most regular people would not have the capital to invest in, such as:
Large apartment complexes
Office buildings
Healthcare facilities
Retirement facilities
Shopping malls
Retail plazas
Industrial buildings
Factories, warehouses, and other industrial buildings
Public REITs are traded on the stock exchange, where investors can purchase shares in the same way you would buy shares of Apple, Amazon, or any other publicly-traded company.
While they are publicly traded the same as any other stock, REITs have unique characteristics that make them different from many other stocks.
The first and most obvious difference is that REITs only invest in real estate assets.
The most crucial difference between REITs and other stocks is their distribution requirements. REITs in the United States are required to pay 90% of their taxable income in the form of shareholder distributions each year. This is in stark contrast to traditional stocks, which are free to set their dividend payout policy however they see fit.
REITs have historically provided excellent total returns
In chapter 12, I reviewed the evidence why rational investors don’t chase dividends; they focus on total returns.
REITs have historically provided strong total returns.
From 1972 to 2019, the S&P 500 provided investors a total annual return of 12.1% compared to total returns of 13.3% for the FTSE NAREIT index of U.S equity REITs1.
Amazingly, the historical total returns on REITs have outperformed the general stock market. What is even better is that since these asset classes have had a low correlation, meaning their prices do not always move in the same direction or magnitude, there appears to be a diversification benefit of adding REITs to a portfolio.