The Fed’s slow and moderate approach to raising interest rates may keep yield-hungry investors looking for income alternatives, says Tony Davidow, asset allocation strategist at the Schwab Center for Financial Research. REITs, or real estate investment trusts, typically deliver higher yields than many other types of income-generating investments. Global REITs can also help increase the diversification of your portfolio. Here’s what you need to know.
REITs are a way to invest in real estate. They are companies that own shares of real estate properties, mortgages or both, and they’re generally traded on public exchanges, similar to stocks. You can buy and sell shares of REITs, and there are mutual funds and exchange-traded funds (ETFs) that own portfolios of REITs. Global REITs include investment within and outside of the U.S.
Over the past 11 years or so, global REITs nearly matched the return of U.S. stocks, and they exceeded the return of international stocks. Even more compelling, REITs paid higher dividend yields than U.S. and international stocks in 2016.
Growth outside U.S. borders is accelerating. According to the International Monetary Fund, more than three quarters of global growth comes from emerging markets, and many countries have GDP growth rates exceeding the pace of U.S. expansion. Including global REITs in your portfolio could help you capture some of the growth these countries generate.
About 35% of REIT assets tracked by the FTSE EPRA/NAREIT Global Index operate outside the United States. And, as you’ll see next, the world of global REITs encompasses numerous and varied global real estate sectors.
In 2016 the total market value of global REITs included in the FTSE EPRA/NAREIT Global REIT Index was just over $1.1 trillion, according to the National Association of Real Estate Investment Trusts (NAREIT).
REITs invest in a wide range of commercial properties, such as office complexes, apartment buildings, shopping malls, hotels and even alternative forms of “property,” like data storage. The chart above shows the real estate sectors included in the FTSE EPRA/NAREIT Global Index.
REITs can add diversification to your portfolio because they tend to have lower correlations with traditional asset classes, Tony says. Even with correlations rising in recent years, asset classes generally don’t move up and down in lockstep. So owning many different asset classes can help smooth out returns over time. As you can see in the chart above, an asset class may be the top performer one year only to be near the bottom the next.
REITs (represented by the yellow squares) are especially prone to such volatility, but they still play an important diversification role. It’s also important to note that the risks of REITs are similar to those associated with direct ownership of real estate—such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
“REITs deliver attractive income, but they are equities, so they’re going to trade like equities—and with additional risks, such as interest rate risk.” Tony says. And global REITs also carry the additional risks of international investments.
Global REITs have been providing attractive yields relative to many equity and fixed-income asset classes. Tony says that with bond interest payouts still near historically low levels, and the dividend yield on the S&P 500® hovering around 2%, it makes sense that global REITs have become popular with investors in search of income. The average yield for a global REIT index in 2016 was more than 4%, nearly double the dividend yield of the S&P 500.
Despite mixed news about the international economy, we believe there are still global growth opportunities—and investing in global REITs can be an effective way to capitalize on some of that growth. For the past 11-plus years, global REITs (the gold line in the chart) have outperformed international developed-market stocks (the blue line) while nearly keeping pace with U.S. shares (the green line).
If you have the appetite for higher volatility, REITs can serve as a nice complement to a traditional mix of stocks and bonds by offering both diversification and the potential for growth and income. (Speaking of income, you may want to hold REITs within a tax-deferred account. Unlike other stock dividends, the bulk of REIT dividend payouts are taxed as ordinary income, with a current potential top rate of 43.4%.)
REITs offer another potential benefit to your portfolio. “As part of your equity allocation, REITs can provide a long-term hedge against inflation,” Tony says. That’s because inflation typically leads to higher real estate values and rising rents. Bear in mind that REIT prices tend to rise along with inflation—though they can lag somewhat, which is why you’ll typically see those inflation-hedging effects over the long term.