Hedging Stocks with Real Estate Investment Trusts
“…for investment periods of 20, 25, and 30 years, the compound annual returns from equity REITs have exceeded those of the S&P 500 Index … investing in REITs helps lower risk and increase returns on a portfolio of stocks and bonds.”– Stephanie Krewson-Kelly, Educated REIT Investing
Can day laborers earn money from space as landlords or lenders? Congress created Real Estate Investment Trusts (REITs) in 1960 to enable small investors access to commercial and recreational property investments—like Trump’s– without big capital obligated long term. REITs let small investors avoid hassles of nighttime plumbing, landlord law, and tax accounting and they need not pay the fees or face mysteries and illiquid shares in private REITs. With tariff uncertainty rampant, a declining dollar, and deregulation daunting, REITs diversify stock portfolios. Buy and sell REITs or REIT ETFs in a jiffy on the stock market!
With mandatory distributions, Krewson-Kelly shows: “Between 1977 and 2019, the 7.1% average yield offered by REITs is 110 basis points higher than the average yield on 10-year US Treasuries and 440 basis points more than the S&P 500 Index during the same period.” According to CEM Benchmarking, 2019, REIT returns relate closely to private real estate (0.91), correlate negatively to long term bonds (0.03) and only half relate to equities (0.53 to 0.62). The CEM 2019 Study found that “except for US bonds, REITs had the highest Sharpe Ratio, reflecting their above-average returns and moderate volatility.” More than eighty million American investors buy REIT mutual funds and ETF’s and over thirty REITs qualify for the S&P 500. REITs own real estate, lease it, manage it and mortgage it.
The IRS demands that REITs distribute 90% of taxable income to avoid corporate double taxation. With limited retained earnings, REITs must issue new shares more periodically than corporations, so they must perform well enough to attract new investors. Analyst and underwriter scrutiny discourages financial shenanigans. REIT dividends are non-qualified, but some of their dividends are taxed as low-rate capital gains or non-taxable returns of capital, but capital losses are not passed through. REIT owners benefit from depreciation deductions and Section 199A Trump Tax which enables investors to deduct up to 20% of ordinary income. Thus REIT owners get better after-tax performance than C Corp owners.
Savvy investors choose REIT styles carefully and monitor management with fundamental analysis. Health-care REITs, for instance, grew from “Population growth, aging demographics, shifts in consumer preference (away from hospitals and toward more convenient medical office buildings)…”—Krewson-Kelly.
Skyscraper REITs renting top dollar office space can do well in economic booms but slow construction and home offices make over-building and empty floors problematic.
Warehouse storage and light manufacturing buildings get built faster with demand, so oversupply is less problematic and income more regular. E-commerce thrives with warehouses.
Billboards, self-storage, cell tower or post office lands are all specialized REITs seeking predictable income from dependable economic activities.
Mall shopping space also rents at high prices to tenants in “triple-net lease” arrangements that pass costs on to tenants—lowering risk. Long leases protect owners from temporary distress with rents that outlast recessions.
Hotel, restaurant and golf courses ownership is more likely to have dividends that fluctuate with the economy as people cut back on luxuries in recessions. REITs must hire managers for hotels because they are operating companies, not passive investments. In good times, hotels raise prices quickly to give some of the best REIT returns.
Residential REITs, with returns related largely to local employment, have assets over $150 million in apartments, manufactured homes and single-family homes. REITs don’t dominate private home rentals because local owners usually manage tenants and property better.
Mortgage backed REITS (mREITs) lend money directly to property owners or indirectly through government agencies like Fannie Mae with dividends tied not to stocks, but to mortgage interest rates.
Only one REIT entered bankruptcy in 2008, but most suspended dividends to preserve capital which they then used to purchase realty at low prices. Before 2011, Green Street found little relationship between changes in Treasury Rates and Real Estate performance. But since then, REIT performance became more interest sensitive and it became wiser to buy at the end of economic distress. Diversify opportunity with REITs!
Robert Arne, EA, CFP, MS, of Carpe Diem Financial Life Planning, gives holistic financial advice as his client’s fee-only fiduciary. He serves mostly Santa Cruz Mountain dwellers. These articles must not be read as personal financial, mortgage, tax or investment advice; consult appropriate professionals.