REITS as a separate asset class?

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ophir
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REITS as a separate asset class?

Post by ophir »

I would like to hear your wisdom and thoughts regarding using a REITs within an asset allocation plan.
My impression is that opinions are mixed. Some arguments that I hear in favor of REITs are:
1. The behavior is unique, and lies between stocks and bonds (guaranteed future payments with an appreciation potential). Thus, they can be a good diversifier.
2. Real estate has a significant weight within the global wealth, so REITs can approximate this within a portfolio.

On the other hand, one may argue that REITs are just stocks. Period. They are a sector with a certain (limited) weight within the total market portfolio, with no reason to overweight it more than any sector.

I would love to learn the opinion of the knowledgeable participants of this excellent forum.

Thanks,
Ophir
CaveatEmptor
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Post by CaveatEmptor »

Their correlation with the overall stock market is quite variable -- it used to hover around 0.5 but has been closer to 0.9 for the last couple of years (to see the correlation graph over time go to http://www.assetcorrelation.com/user/enter_time_corr and enter VTSMX and VGSIX then choose "10 years" for the time frame).

Their inflation-hedging characteristics are probably quite different from those of the stock market as a whole -- I would expect it to be better but I have no actual data on this (maybe someone else has more solid info on this facet of REITS and can comment on how they did, e.g., in the inflationary 1970s).
tonythered
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Re: REITS as a separate asset class?

Post by tonythered »

ophir wrote:I would like to hear your wisdom and thoughts regarding using a REITs within an asset allocation plan.
My impression is that opinions are mixed. Some arguments that I hear in favor of REITs are:
1. The behavior is unique, and lies between stocks and bonds (guaranteed future payments with an appreciation potential). Thus, they can be a good diversifier.
2. Real estate has a significant weight within the global wealth, so REITs can approximate this within a portfolio.

On the other hand, one may argue that REITs are just stocks. Period. They are a sector with a certain (limited) weight within the total market portfolio, with no reason to overweight it more than any sector.

I would love to learn the opinion of the knowledgeable participants of this excellent forum.

Thanks,
Ophir
Hi,
I am no expert, so remember that as you read my thoughts!

REITs are supposedly a very good diversifier due to their ups and downs not matching the broad market. From what I've seen though, they swing so wildly that you'd have to rebalance very, very frequently to capture that benefit. The Vanguard REIT fund consists of such a small number of stocks compared to their other funds that you can't consider it to be truly diversified on its own. If you pair it with smallcap, midcap, or total stock market funds, you are simply duplicating/overweighting.

I recently sold my REIT fund entirely to try to simplify my portfolio. I felt it caused me to have to watch everything too closely (to try to capture the swings) instead of being able to set-and-forget my portfolio and enjoy life. I went with a variation of Trev H's simplified buy-and-hold portfolio, and that portfolio includes the same stocks that are in the REIT fund, so I have that exposure (I'm just not holding the fund separately).

Rick Ferri and Larry Swedroe (very intelligent folks!) do recommend REITs as a diversifier, but recommend you don't go overboard. See some Q&A/discussions here:
http://www.moolanomy.com/440/ask-the-ex ... 008-issue/
http://www.bogleheads.org/forum/viewtopic.php?p=439125
jon-nyc
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Post by jon-nyc »

I taxonomize my portfolio into 4 buckets:

Equities
Bonds
Alternative
Cash


I put REITs in Alternative. Also in the Alternative bucket is my gold, and short term foreign treausries.
heyyou
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Post by heyyou »

I own REITs in my 1/N sliced portfolio. They were on the Callan Periodic Table when I was allocating. If I was allocating now, I would likely use Trev's 4-way portfolio.

During my accumulation years, my savings rate was far more important than my allocation choices.
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Rick Ferri
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Post by Rick Ferri »

CaveatEmptor wrote:Their correlation with the overall stock market is quite variable -- it used to hover around 0.5 but has been closer to 0.9 for the last couple of years (to see the correlation graph over time go to http://www.assetcorrelation.com/user/enter_time_corr and enter VTSMX and VGSIX then choose "10 years" for the time frame).
The correlation between REITS and commons stocks varies considerably over time. In the mid-2000s, the correlation was negative and has since turned positive during the economic downturn. There is no telling what the correlation will be over the next 10 years

The question to ask is why REIT correlation with stocks is dynamic. It is because REITS are a separate asset class from common stock. The businesses are run differently, collateralized differently, taxed differently and earnings are distributed differently. That has not changed. Accordingly, we can expect correlations to shift in the future.

Rick Ferri
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Post by wannabe_CPA »

jon-nyc wrote:I taxonomize my portfolio into 4 buckets:

Equities
Bonds
Alternative
Cash


I put REITs in Alternative. Also in the Alternative bucket is my gold, and short term foreign treausries.
I'm very similar in terms of a "taxonomy", even though currently my last two categories have nothing in them as any Cash I have is for anticipated contingencies at the moment. But basically same idea.

But I put REITs in the Equity bucket, specifically domestic equity. At some point I plan to put a slice of the domestic equity portion of the portfolio in a REIT, as a (sub)category diversifier since it's not always so lock step with other assets.

But I won't mess with it until the REIT itself would be at least 5% of the total portfolio because, imho, it just isn't worth it to have "slices" that are less than that. So I may never mess with it.

I'll add a SCV domestic index to the portfolio before I ever mess with the REIT (I consider Total Market a large blend fund, so a SCV and LB split makes sense to me), and it just seems two holdings in what I (perhaps erroneously) consider to be the same asset class is too many already.

All this is, of course, is splitting hairs. This comment is worth less than you paid for it. :D
Valuethinker
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Re: REITS as a separate asset class?

Post by Valuethinker »

ophir wrote:I would like to hear your wisdom and thoughts regarding using a REITs within an asset allocation plan.
My impression is that opinions are mixed. Some arguments that I hear in favor of REITs are:
1. The behavior is unique, and lies between stocks and bonds (guaranteed future payments with an appreciation potential). Thus, they can be a good diversifier.
2. Real estate has a significant weight within the global wealth, so REITs can approximate this within a portfolio.

On the other hand, one may argue that REITs are just stocks. Period. They are a sector with a certain (limited) weight within the total market portfolio, with no reason to overweight it more than any sector.

I would love to learn the opinion of the knowledgeable participants of this excellent forum.

Thanks,
Ophir
During the credit crunch the financial leverage of REITs became paramount in driving their share prices.

Although real estate is conceptually a different asset class, and the textbooks treat it as such, in the form that most individual investors have available to them (REIT index funds) REITs behave more like small cap value stocks than anything else due to the leverage effect and the premium/discount to NAV effect.

If you have access to TIAA RE annuity, this is more like the institutional RE funds that the textbooks are talking about: a purer play on commercial RE.

David Swensen is fairly careful to make the distinction although the old edition of his personal finance book says REITs should be used as a substitute.

However recent market experience suggests you are taking on a high level of volatility.

Whereas the attraction of commercial RE is precisely the lower returns but lower volatility than equities.

Accordingly I would treat REITs as a small cap value equity investment and set your target asset allocations on that basis.
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simplesimon
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Post by simplesimon »

I chose to overweight REITs a little bit (10% of the equity portion of my portfolio) because I've read that most of their returns (something like 90%? I'll have to refer back to Swedroe's "Alternative Investments" book) come from the rent income they collect and distribute.

I see that Rick Ferri has laid out other related reasonings.
natureexplorer
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Post by natureexplorer »

I hold about 5% of my portfolio in VNQ in a Roth IRA as I am a permanent renter. I see this somewhat as a hedge against increasing rents. I also rationalize this, by thinking that the stock market capitalization weights are not correctly representing real estate capitalization even with many non-REIT companies owning real estate. However, those 5% (in a 60% equity position) are probably outdoing it.

I am however no longer reinvesting dividends (let alone add to it) as I now see the tax-advantaged space to be more valuable for bonds. Due to this I have no separate asset class for REITS, but lump them in with an allocation I have for US Small Cap. As I am otherwise still accumulating, my percentage allocation to REIT is constantly shrinking. If for some reason my rebalancing bands are triggered to rebalance out of equities, VNQ would be one of the places to start for me.

If I owned any other real estate (for example as a primary residence), I would never buy REITs.

On the hand side, if I had plenty of tax-advantaged space, I would probably be comfortable holding twice my current allocation in REITs as a separate asset class, because rent is my primary non-discretionary expense.

Is this "hedge-against-increasing-rents"-thinking wrong?
Derek Tinnin
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Re: REITS as a separate asset class?

Post by Derek Tinnin »

Valuethinker wrote:
ophir wrote:I would like to hear your wisdom and thoughts regarding using a REITs within an asset allocation plan.
My impression is that opinions are mixed. Some arguments that I hear in favor of REITs are:
1. The behavior is unique, and lies between stocks and bonds (guaranteed future payments with an appreciation potential). Thus, they can be a good diversifier.
2. Real estate has a significant weight within the global wealth, so REITs can approximate this within a portfolio.

On the other hand, one may argue that REITs are just stocks. Period. They are a sector with a certain (limited) weight within the total market portfolio, with no reason to overweight it more than any sector.

I would love to learn the opinion of the knowledgeable participants of this excellent forum.

Thanks,
Ophir
During the credit crunch the financial leverage of REITs became paramount in driving their share prices.

Although real estate is conceptually a different asset class, and the textbooks treat it as such, in the form that most individual investors have available to them (REIT index funds) REITs behave more like small cap value stocks than anything else due to the leverage effect and the premium/discount to NAV effect.

If you have access to TIAA RE annuity, this is more like the institutional RE funds that the textbooks are talking about: a purer play on commercial RE.

David Swensen is fairly careful to make the distinction although the old edition of his personal finance book says REITs should be used as a substitute.

However recent market experience suggests you are taking on a high level of volatility.

Whereas the attraction of commercial RE is precisely the lower returns but lower volatility than equities.

Accordingly I would treat REITs as a small cap value equity investment and set your target asset allocations on that basis.
The Fama/French model only explains about half of the variation of returns of REITs while the same model explains 99 percent of the returns of small cap value. That makes REITs unique.
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Robert T
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Post by Robert T »

.
1. HOW UNIQUE ARE REITs?
  • FWIW - here's a cut and paste of an earlier M* post with my earlier analysis of how 'unique' REITs actually were, relative to other sector funds.

    Fama Jr. in this paper compared the ability of the 3 factor model to explain the variability of REIT returns versus other industry sectors. A model R^2 for REITs of 0.22 and for other industry sectors of 0.67 (& for real estate of 0.74) has often led to the conclusion that REITs are a separate asset class (from other industry sectors). One concern I have with the paper is that it was comparing results over different time periods (July 1963-December 1992 for the industry sectors versus July 1992-June 1997 for REITs).

    I redid the estimates for the same time period and added the default and term factors and reached a slightly different conclusion.

    Code: Select all

    
    Feb 1993 - Dec 2004 
    [period used determined by data available for DFA REITs and TERM and DEFAULT factors]
    
    Factor loadings
    
                  Beta   SmB    HmL    Term  Default    R^2
    DFA REITs     0.51   0.39   0.69      -       -    0.38
    RE Industry   0.76   0.59   0.69      -       -    0.43
    DFA REITs     0.48   0.39   0.66    0.20   0.29    0.39
    RE Industry   0.74   0.58   0.65    0.28   0.23    0.44
    
    RE=Real Estate 
    The 3 and 5 factor regression results show similar explanatory power for both REITs and real estate sector industry stocks. The factor loadings are also not vastly different between the two. The TERM and DEFAULT factors were not significant and didn't seem to add much explanatory power. The model R^2 for the real estate industry presented in the Fama Jr paper was 0.74 which I managed to replicate over the same sample period used in his paper. The Fama Jr paper lists the variable as 'homes', but on the Ken French website it is listed as 'real estate' and includes real estate operators (non-resident buildings, apartment buildings, other than apartment, residential mobile home), real estate agents and managers, developers etc .[REITs are not included in the real estate industry variable].

    IMO the focus on the comparison is important. REITs seem to have similar characteristics to real estate stocks (according to the 3F model they are not so uniquely different from common stocks). In addition, as illustrated in earlier posts, the FF model has a similar weak explanation of other sector fund performance (energy, precious metals and health care – FF R^2 range from 0.02 to 0.54) for similarly short time periods. The Industry Costs of Equity paper suggests that for longer time periods the power of the model increases.

    So based on the above analysis - the argument for REITs having unique risk and being a separate asset class based on the weak explanatory power of the three factor model seems tenuous.
2. REASONS FOR EXCLUDING REITS
  • Again, from an earlier M* post. The common reasons for inclusion of REITs, as summarized in "Why Real Estate?" in the Journal of Portfolio Management (Sept. 2005) are: (i) to reduce risk; (ii) achieve returns comparable to other asset classes; (iii) hedge against unexpected inflation; (iv) provide high cash flow; and (v) better reflect the overall investment universe (only about 2% of real estate value is securitized).

    IMO none of these reasons seem particularly compelling for a value and small cap tilted portfolio during an accumulation phase (see below - just my opinion - I'm sure many will disagree). In addition to limited space in tax advantages accounts, the reasons I exclude REITs are:

    1. Reduces portfolio risk but opportunity cost too high (or return loss exceeds diversification benefit). For my broadly diversified small and value tilted portfolio, the space taken up by REITs reduces factor exposure, the latter being more important to achieving objective targets than the benefits of adding REITs. In back-tested data, adding REITs lowered the Sharpe ratio. Lower volatility was at the expense of higher return.

    2. Not so unique risk? REITs seem more like a sector rather than an asset class. Even though market, value, size (and fixed interest) exposure only explains about 25 percent of the movement of the REIT index, with about 75 percent of the returns being unique to REITs, the same argument can be made for most sectors or industries, with the three factor model having as low or even lower explanatory power. The three factor model results do not seem to make a special case for REITs as a separate asset class beyond other sectors.

    3. Not the most efficient protection against unanticipated inflation: This can be provided with more certainty with inflation protected securities than by REITs, and the opportunity cost of lower returns to inflation protected securities can be off-set with a higher equity allocation.

    4. No current need for high cash flow (as produced by REITs) This is not an objective during an accumulation stage IMO.

    5. Closer to overall real estate investment universe than it appears While the argument that an overweigthing to REITs is needed to reflect the 'market portfolio' as only about 2% of real estate value is securitized seems appealing, this seems to imply that our house is also real estate exposure as it is part of this un-securitized portion. So we maybe closer to the market real estate allocation percentage than it appears (although more concertrated).

    6. Wandering factor loadings complicate implementation. A characteristic of sector or industry factor loadings is that they 'wander' through time (Fama-French, Industry Cost of Equity, 1992). Hence overweighting a particular industry can cause significant variation in overall portfolio risk-return profiles. This can be particularly disruptive to a portfolio targeting specific factor loadings. Fama Jr. (2001) sums up the 'wandering' loadings in the following extract which we believe is applicable to all sectors (including technology, health, energy, precious metals, and REITs): "Industries [or sectors] drift in and out of asset classes. They get bigger and smaller, healthier and more distressed through time. Tech stocks might be growth stocks today, but further earnings disasters could sweep them into the value category. Sorting stocks on secondary criteria like industries can therefore cause a portfolio to drift across asset classes. Investors should focus on the cost of capital [i.e. value and size loadings, not sector exposure]"

    Just my reasoning.
Robert
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Re: REITS as a separate asset class?

Post by richard »

@Robert,
Derek Tinnin wrote:The Fama/French model only explains about half of the variation of returns of REITs while the same model explains 99 percent of the returns of small cap value. That makes REITs unique.
Based on your post, this is incorrect. In particular, many sectors have low FF R^2s, especially over short time periods.

Two things I frequently hear about REITs are (1) more leverage than other sectors and (2) more stability (either as to NAV or dividend stream) than other sectors or the market.

Do you have any data on these claims?

There are many types of REITs. For example, some concentrate on holding mortgages, some concentrate on more exotic holdings (they use REITs as a vehicle due to tax advantages), etc. Vanguard's REIT fund focuses on REITs which purchase office buildings, hotels and other real property.

How a REIT behaves likely depends on the type of REIT it is. I don't see any reason to consider everything that operates as a REIT as fungible.
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Post by CaveatEmptor »

Robert T wrote:3. Not the most efficient protection against unanticipated inflation: This can be provided with more certainty with inflation protected securities than by REITs, and the opportunity cost of lower returns to inflation protected securities can be off-set with a higher equity allocation.
First thank you Robert for very useful information and thoughts. About the above item 3, a case can be made for not acquiring all of one's inflation protection through securities bought from the inflator -- governments that inflate have a strong incentive to fib the inflation numbers (or even grossly understate, e.g., Argentina is routinely off by a factor of 2 or more). Do you have any numbers on how good REITS are, as hedges against unanticipated inflation?
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Re: REITS as a separate asset class?

Post by cjking »

ophir wrote:On the other hand, one may argue that REITs are just stocks. Period. They are a sector with a certain (limited) weight within the total market portfolio, with no reason to overweight it more than any sector.
The logic of this argument would imply that I should never explicitly include bonds in my asset allocation. The cheapest way I can gain exposure to bonds is via an iShare ETF, but if I'm already exposed to the share index, then explicitly buying shares in a bond ETF would (according to the argument) be to overweight my bond exposure.

I also feel that one should distinguish between REITs that are property funds and REITs that are property businesses. Treat the "businesses" as equities like any other, use the "funds" for obtaining exposure to property as an asset class.

I would call a REIT a fund if just owns properties and collect rents, does little or no development beyond refurbishing existing buildings, and has no employees. Typically it will have a board of directors, who will outsoure management of the property portfolio to an investment company, possibly one with a recognisable brand name that also runs equity and bond funds. (I am in the UK so it probably won't help to mention examples.) Hardly any of the companies in UK property sector qualify as "funds" rather than "businesses" according to my criteria.

The conceptual mistake that leads to the regular argument being repeated in this thread is the idea that REIT allocation = property allocation. Most REITs are not good vehicles for getting exposure to property, and it is possible (for some investors at least) to get a property allocation without using REITS.

Listed shares in selected closed-end "funds" are a practical way into the property asset class for many ordinary investors, just as shares in an iShare bond ETF are the optimum way for me to get bond exposure. The fact that the iShare bond ETF happens to be a share in no way influences my thinking about what my bond exposure should be. Similarly, my asset allocation to property is in no way influenced by the fact that one convenient way to obtain it is by buying shares in selected investment trusts. (I do have other options, for example property unit trusts, and also unitised property funds offered by most UK insurance companies.)
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Post by cjking »

For what it's worth, the tax system in the UK recognises that (business) profits, rent and interest are three different things, and taxes them separately, I think. (I'm not an accountant, so I may be mistaken.) So I would say it is fairly clear that equities (businesses) property (rents) and bonds (interest) are the major asset classes.

I've never studied economics, but I believe economics also distinguishes between rent and business profits (hence the distinction in the tax system.)

A company can earn money from any of the three sources, but one whose gross income consists of more than 90% (my criterion) rent with the rest being interest is not a business.

On the other hand, a company that makes substantial profits/gains from speculation and development is probably a business, even if more than half its income does come from rents.

(I hope I haven't confused the issue.)
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Post by Lbill »

I recall an earlier thread (can't locate it) started by Rick Ferri in which SmallHi took the same position as Robert - specifically, that REITS essentially affect returns by increasing Beta risk. A better way to diversify and improve risk-adjusted return is across small and value, rather than across sectors such as REITS; i.e., REITS = Stocks. If I'm gonna play sectors I'd rather add Energy. If you want REITS, just add some VISVX - it has a big chunk of REITS.
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Post by Rodc »

Lbill wrote:I recall an earlier thread (can't locate it) started by Rick Ferri in which SmallHi took the same position as Robert - specifically, that REITS essentially affect returns by increasing Beta risk. A better way to diversify and improve risk-adjusted return is across small and value, rather than across sectors such as REITS; i.e., REITS = Stocks. If I'm gonna play sectors I'd rather add Energy. If you want REITS, just add some VISVX - it has a big chunk of REITS.
?? Robert is reporting rather low beta, at least for DFA REITs.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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Post by cjking »

Something I forgot to include in my first post in this thread: the ideal REIT will have little or no leverage. I'm not interested in property fund managers who want to introduce blow-up risk to my investments so they can earn higher fees. (During the last few months, I've been pleased to note that a number of my funds have renegotiated their investment-manager contracts so they are now paid a percentage of net rather than gross asset value.)
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Post by Rodc »

cjking wrote:Something I forgot to include in my first post in this thread: the ideal REIT will have little or no leverage. I'm not interested in property fund managers who want to introduce blow-up risk to my investments so they can earn higher fees. (During the last few months, I've been pleased to note that a number of my funds have renegotiated their investment-manager contracts so they are now paid a percentage of net rather than gross asset value.)
That was a huge factor over the last couple of years that I personally had not factored into my thinking.

I think the case can go either way on these, certainly not a must have asset. Knowing what I do now if I was starting over I would likely take a pass. But, in the interest of practicing discipline I'm keeping my modest allocation.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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Post by femur »

Rodc wrote:
cjking wrote:Something I forgot to include in my first post in this thread: the ideal REIT will have little or no leverage. I'm not interested in property fund managers who want to introduce blow-up risk to my investments so they can earn higher fees. (During the last few months, I've been pleased to note that a number of my funds have renegotiated their investment-manager contracts so they are now paid a percentage of net rather than gross asset value.)
That was a huge factor over the last couple of years that I personally had not factored into my thinking.

I think the case can go either way on these, certainly not a must have asset. Knowing what I do now if I was starting over I would likely take a pass. But, in the interest of practicing discipline I'm keeping my modest allocation.
Does anybody have the info regarding the average leverage ratio in Vanguard's REIT index?
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Post by Lbill »

This is a much better representation of what SmallHi said about REITS, consistent with the data shared by Robert (who also contributed to the thread I am referencing).
Bottom line, size and value tilts are a worthwhile consideration for any investor and should be considered for the CORE of anyone's investment allocation. It is generally unnecessary to include REITS after one has attained their multifactor tilt.
Here's the thread, in which Rick Ferri discussed his "Core Four" allocation: VTSMX, VFWIX, VGSIX, VBMFX. Well worth reading.
http://www.bogleheads.org/forum/viewtop ... highlight=
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Post by Felipe B. »

I like jon-nyc's portfolio construction (REITs & commodities into alternative investments). For the retirement accounts, it's even more suitable due to tax implications. You could also put REITs into a dividend payout subcategory. I think REITs are unique that 90% of income must be paid out to investors, but the fundamentals of the investment remains the same - investors buy long or short in the hopes of making profit. I wouldn't also discount the fact that it's a sector investment, which should refrain you from holding too much.
And lastly, it's good to be a fan of not-so-trendy investments.
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Post by Valuethinker »

femur wrote:
Rodc wrote:
cjking wrote:Something I forgot to include in my first post in this thread: the ideal REIT will have little or no leverage. I'm not interested in property fund managers who want to introduce blow-up risk to my investments so they can earn higher fees. (During the last few months, I've been pleased to note that a number of my funds have renegotiated their investment-manager contracts so they are now paid a percentage of net rather than gross asset value.)
That was a huge factor over the last couple of years that I personally had not factored into my thinking.

I think the case can go either way on these, certainly not a must have asset. Knowing what I do now if I was starting over I would likely take a pass. But, in the interest of practicing discipline I'm keeping my modest allocation.
Does anybody have the info regarding the average leverage ratio in Vanguard's REIT index?
Green Street Advisers may have the data for the sector averages. It moves up and down.

Inevitably expanding cyclically in a bull market, and shrinking in a bear market in RE like we are now, due to the lending preferences of banks.

REITs do not, empirically, behave like Commercial RE-- or at least not in the recent past as much as we had hoped.
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Post by Valuethinker »

cjking wrote:For what it's worth, the tax system in the UK recognises that (business) profits, rent and interest are three different things, and taxes them separately, I think. (I'm not an accountant, so I may be mistaken.) So I would say it is fairly clear that equities (businesses) property (rents) and bonds (interest) are the major asset classes.

I've never studied economics, but I believe economics also distinguishes between rent and business profits (hence the distinction in the tax system.)

A company can earn money from any of the three sources, but one whose gross income consists of more than 90% (my criterion) rent with the rest being interest is not a business.

On the other hand, a company that makes substantial profits/gains from speculation and development is probably a business, even if more than half its income does come from rents.

(I hope I haven't confused the issue.)
No.

It distinguishes, AFAIK, between income and capital gain.

REITs are new. REITs are a special tax structure, that unlike a property company (but like an investment trust) can flow through the profits directly to investors as dividends, without paying corporation tax (28%), yet still utilizing the capital cost allowances (depreciation) allowable to corporate entities.

So the profits after net depreciation and management charges.

Rent is just 'income' for a UK property company (and is VATable of course).
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Post by stratton »

Valuethinker wrote:Green Street Advisers may have the data for the sector averages. It moves up and down.
http://www.greenstreetadvisors.com/abou ... earch_nav/

We appear to be a bit pricy right now.

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Note: This url for Greenstreet appears to be constant so the chart may change in the future from the posting date.

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Post by metalman »

Real estate is indeed a separate asset class. But investing in real estate, particularly commercial real estate, is out of reach financially for most people. REITs seem to me to be a surrogate for such investments, and not a very good one at that. The big investors skim the best of it and leave the rest for the peasants and their REITs.
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Re: REITS as a separate asset class?

Post by burma7734 »

I wanted to kick this old thread back up because I learned a valuable lesson today. I had been under the mistaken impression that holding a REIT index (VNQ) gave me exposure to an asset class that was not captured by the Total market index. However, as I have read several threads here and the wiki articles, I now understand that VNQ is just a sector of the total market index. I struggle to see why REITs are treated as a separate assert class in most asset allocation strategies, rather than just an equity sector.

By owning the Total US market index (VTSAX), I have a market weighted 3.5% exposure to real estate equity holdings. What is the logic in overweighting this sector by 5 to 10x its market weighting? Why not do the same for utility stock, or health care?

Just to convince myself of this, I looked into some of the holdings of REIT index. SPG is the top holding at 10.8% of the portfolio. Vanguard REIT index is the the #1 fund shareholder of this company; #3 is Vanguard Total Market Index. I even followed the same exercise for some of the International REIT index to similar results.

It just seems contrary to the market cap index philosophy to make a "bet" so heavily on one sector with a heavy overweight asset allocation. Ignoring recent performance and 0.90 correlation to the broad market, is there really a fundamental reason that will drive above market returns in the REIT sector?
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Re: REITS as a separate asset class?

Post by xram »

VTI, VBR, VTWV, SCHH, VXUS, VEA, VWO, VSS, FM, VNQI, VBTLX, VFITX, SCHP, VWITX, IBONDS, EEBONDS, EF(EverBank), UTAH-529
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Re: REITS as a separate asset class?

Post by burma7734 »

Thanks for the Swedroe article. Sure, REIT can be a good sector for tactical asset allocation, as could utility stocks, or consumer discretionary. It just does not seem they should be regarded as a separate asset class. I thought I was purchasing something different in VNQ that was not covered by the Total Market, but in fact is just buying more of a specific subset of stocks.

I don't follow the claim that REIT is loosely (0.4 Larry sites) correlated to SP 500. Data from Assetcorrelation shows 0.87 correlation to Large Caps over the 2 yr and 5 yr period. At 10 year chart on morningstar shows similar correlation. I have seen some argue that "historically" there was less correlation, but it seems we are living in more correlated world these days.

From this Vanguard article:
Future correlations may also differ from those in the past because of changing economic and market regimes.
Would I be wrong to sell my VNQ and return to a market weighting on REIT through my Total Market holdings? Especially given the run up in valuation mentioned by Swedroe and others, perhaps it is a good strategic and tactical decision.
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Re: REITS as a separate asset class?

Post by Beagler »

Valuethinker wrote: ... in the form that most individual investors have available to them (REIT index funds) REITs behave more like small cap value stocks than anything else....
Accordingly I would treat REITs as a small cap value equity investment and set your target asset allocations on that basis.
FWIW, here's the M* X-Ray of VGSIX:
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Re: REITS as a separate asset class?

Post by stevewolfe »

I believe he said they behave like small cap value... Not that they were small cap value...
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Re: REITS as a separate asset class?

Post by Doc »

burma7734 wrote:Would I be wrong to sell my VNQ and return to a market weighting on REIT through my Total Market holdings?
Remember most real estate investment is not traded on the stock market. Therefore the amount of REITs you see in TSM is much less than the true weight in TM (Total Market).
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Re: REITS as a separate asset class?

Post by tetractys »

US REITS are unique in structure and behavior, even when compared to small value, other country REITS not so much. -- Tet
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Re: REITS as a separate asset class?

Post by burma7734 »

Doc wrote:
Remember most real estate investment is not traded on the stock market. Therefore the amount of REITs you see in TSM is much less than the true weight in TM (Total Market).
That is the essence of the argument to overweight the REIT sector. Since total equity capitalization of REITs is only fractionally representative of the total market, so one might "tilt" their equity holdings as summarized by this article from Rick Ferri.

It just seems misleading to talk about REIT as an "asset class" rather than an sector of the equity market. I think it is important for investors to realize buying a fund like the REIT Index is not exposure to some new asset class that is not covered in the Total Market, but a strategic decision to overweight a particular equity sector.
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Re: REITS as a separate asset class?

Post by Doc »

VGSLX R Square vs. MSCI World NR USD:

3 yr - 68
5 yr - 63
10 yr - 55
15 yr - 36

http://performance.morningstar.com/fund ... ture=en-us

That seems to be a pretty low correlation to me which gives credence to REITS as a separate asset class. That in turn would indicate one might want to overweight REITS with respect to what is in TSM.
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Re: REITS as a separate asset class?

Post by burma7734 »

1) correlation should not define an asset class
2) Why compare a US REIT index to 23 country developed market index? I could pull out several baskets of US stocks that have low correlation to this index, but that does not mean they are a unique asset class.

REIT is not unique from the total equity market. Every one of the 111 stocks held in REIT (VNQ/VGSLX) are also holding of Total US Market (VTI/VTSAX). They constitute about 3% of the holdings of the total market funds. Therefore REIT is a sector or portion of the total equity market, not an asset class unique from equities as people often talk about them.
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Re: REITS as a separate asset class?

Post by Doc »

burma7734 wrote:1) correlation should not define an asset class
2) Why compare a US REIT index to 23 country developed market index? I could pull out several baskets of US stocks that have low correlation to this index, but that does not mean they are a unique asset class.

REIT is not unique from the total equity market. Every one of the 111 stocks held in REIT (VNQ/VGSLX) are also holding of Total US Market (VTI/VTSAX). They constitute about 3% of the holdings of the total market funds. Therefore REIT is a sector or portion of the total equity market, not an asset class unique from equities as people often talk about them.
Definition of 'Asset Class'
A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations. The three main asset classes are equities (stocks), fixed-income (bonds) and cash equivalents (money market instruments). Investopedia explains 'Asset Class'
It should be noted that in addition to the three main asset classes, some investment professionals would add real estate and commodities, and possibly other types of investments, to the asset class mix.

Read more: http://www.investopedia.com/terms/a/ass ... z2HsPUZ9Ui
Investopedia explains 'Asset Class'
It should be noted that in addition to the three main asset classes, some investment professionals would add real estate and commodities, and possibly other types of investments, to the asset class mix. Whatever the asset class lineup, each one is expected to reflect different risk and return investment characteristics, and will perform differently in any given market environment

Read more: http://www.investopedia.com/terms/a/ass ... z2HsPqJlaR
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Re: REITS as a separate asset class?

Post by dbr »

It is certainly possible to discern that various subsets of the investment market, based on whatever arbitrary criteria, behave differently from each other, specifically in the distribution of returns they will probably experience. (Distribution can be described by an average, otherwise known as expected return, or return, and by some measure of variation of actual return around the average, otherwise known as risk.) It is also possible to discern that the various return distributions may be correlated with each other to some degree.

Taking all of that, it is possible to attempt construction of an optimum portfolio relative to risk and return by trying to decide what proportion of each "asset class" to hold. It may turn out that some schemes of asset class definition give rise to a clearer and more consistent picture of how to construct an optimum portfolio than others. I have no idea if considering REIT as a class is helpful in that regard or not. The biggest effort in this regard comes from classifying sets of investments according to size and value statistics and then assembling portfolios from those subsets.

A different issue has to do with adding assets to a portfolio that were not there before. In principal this should be the same, as in the larger concept of the investment universe, the previous portfolio was just one where some classes were allocated at zero. So, would REITs be a distinct asset class if one were invested in TSM ex REITs? Does that make commodity investments of some kind an asset class just because they are not in TSM? Is the fact that small cap value stocks are still equities and included in some proportion in TSM, mean these are not asset classes?

Finally, since it is possible to analyze the properties of any portfolio based on any arbitrary sub-classification of its components, how does it matter what the definition of an asset class is? The only criterion I think one always sees in portfolio theory is that asset classes under consideration have enough individual economic units included that there is no diversifiable risk from the start.
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Re: REITS as a separate asset class?

Post by nedsaid »

I have owned REITs and REIT funds for a long time. They have been good diversifiers in my portfolio. They have performed differently than stocks. They had good performance during some tough years in the stock market.

It is surprising however, how volatile this asset class is. So I would not over do REITs in a portfolio. I have seen these go up or down several percent in one day!!!

From what I have read from different threads in this forum, domestic REITs have been bid up in price and are no longer bargains. If you have them, keep them as part of an asset allocation. They are worth having as part of an investment plan. I sure wouldn't pile into these right now.
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Re: REITS as a separate asset class?

Post by F. Lynx Pardinus »

I invested in a REIT fund a long time ago. I eventually ditched it because I remember the tax issues being a pain. Is that still the case nowadays?
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Re: REITS as a separate asset class?

Post by 555 »

It would be interesting to look at correlation between TSM and each of the sectors that it consists of. Some of these correlations might be low, but that doesn't make them separate asset classes. There may be other arguments for and against REITs being a separate asset class, but correlation can't be one of them.
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Re: REITS as a separate asset class?

Post by abuss368 »

Stocks, bonds, real estate, and cash.

Everything else is a spin off of one of those four asset classes.

We have invested in REITs for many years and are thankful for the results. Hopefully those dividend checks will fund retirement someday.

We are invested in the US fund presently. We are trying to better understand the International fund which includes REITs and also a lot of non-REITs.

We plan to stay the course.
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Re: REITS as a separate asset class?

Post by burma7734 »

If you have a Total International fund like VTIAX, you already have some exposure to international REITs at about 3% of that fund.

Without belaboring the semantics, the point I have been trying to make is that REIT holdings are already part of the holdings of many funds including Total Market funds like VTIAX and VTSAX at the market weighting (roughly 3%). REITs are a group within the total stock market (not something outside of the stock market).

It is certainly a valid strategy to overweight holdings in the 118 US REITS stocks if one chooses to do so. Just with the realization that you might already have some exposure to the REIT stocks in your portfolio already.
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Re: REITS as a separate asset class?

Post by SGM »

F. Lynx Pardinus wrote:I invested in a REIT fund a long time ago. I eventually ditched it because I remember the tax issues being a pain. Is that still the case nowadays?
I only invest in REIT funds in tax deferred accounts because the dividends are not qualified and are treated as ordinary income.
Generally the dividends have been higher too.

In terms of are they a separate class, I do not consider them so because of the high correlation to the total stock market. Others can differ in their opinions. I only have 1 % of my total portfolio in REIT funds and all in tax favored accounts so the distinction is not that important to me. If the correlation were lower I would likely have more in REIT funds.
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Re: REITS as a separate asset class?

Post by Valuethinker »

burma7734 wrote:Thanks for the Swedroe article. Sure, REIT can be a good sector for tactical asset allocation, as could utility stocks, or consumer discretionary. It just does not seem they should be regarded as a separate asset class. I thought I was purchasing something different in VNQ that was not covered by the Total Market, but in fact is just buying more of a specific subset of stocks.

I don't follow the claim that REIT is loosely (0.4 Larry sites) correlated to SP 500. Data from Assetcorrelation shows 0.87 correlation to Large Caps over the 2 yr and 5 yr period. At 10 year chart on morningstar shows similar correlation. I have seen some argue that "historically" there was less correlation, but it seems we are living in more correlated world these days.

From this Vanguard article:
Future correlations may also differ from those in the past because of changing economic and market regimes.
Would I be wrong to sell my VNQ and return to a market weighting on REIT through my Total Market holdings? Especially given the run up in valuation mentioned by Swedroe and others, perhaps it is a good strategic and tactical decision.

You would not be wrong to do this. REITs have done well, valuation looks stretched, you already hold REITs in your total market.

The longterm question is whether you want to hold REITs at all?

A purist view says you either should or you should not. Again I counsel that REIT is not a pure Commercial RE investment, that's really only available through TIAA RE annuity which mirrors the structures that institutional investors use to gain access to the asset class. REITs add the risk of additional leverage and management, and behave more as quoted stocks. The diversification benefits are lowered. And we saw this most brutally in 2008, when REITs behaved like specialized financial stocks-- huge drops in price. OK maybe we don't have a crisis like 2008 again for a long time (hope!) but if that happened to you just before retirement--- also many REITs then stopped paying dividends or started paying them in stock, I believe.

An agnostic view says you should buy REITs, but only when they are cheap, particularly in terms of discounts to stated Net Asset Value. Green Street Advisers, for example, publishes on this.

The other side of the agnostic view is that REITs consume tax sheltered space, so you have to have a *very* good argument for holding them against fixed income instruments, where the tax advantages are more or less known, guaranteed.

FOOTNOTE

Just a bit of history on REIT correlations. If you graph what has been going on, year by year, you see an interesting pattern-- at least without me checking so take this with a grain of salt.

Late 90s REITs foundered whilst the market got all excited by Tech Media Telecoms. So low correlation and massive underperformance.

2000s they caught that up in spades as 'value' triumphed. Low correlation with a mehhh market whilst REITs make tracks. Discounts to NAVs close, underlying business fundamentals (earnings and dividend growth) very strong.

Then in 2007 some big REITs got taken over, in retrospect a sign of bubble financing (cheap debt to buy highly valued real estate).

2008-09 the sector becomes a leveraged financial, behaves like banks on speed. Down with the worst of them, then rebound. Meanwhile the business fundamentals deteriorate. So high correlation.

Right now you see better business numbers, however valuations have really moved up as people have been chasing yield. Blue Chip properties, at least in London, are selling for prices similar to 2007-- because investors are dumping bonds and buying Commercial RE viewing the secure tenants as good a risk as an A corporate bond. However secondary and tertiary properties are lagging, way, way behind-- down as much as 50% in value, in line with a lousy economy. (again that is UK specific, perhaps).
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Re: REITS as a separate asset class?

Post by Valuethinker »

burma7734 wrote:, I now understand that VNQ is just a sector of the total market index. I struggle to see why REITs are treated as a separate assert class in most asset allocation strategies, rather than just an equity sector.
The argument (see Swensen and Malkiel) is that they represent the public listed wedge of the vast untraded commercial RE sector. That is a good argument but I think they overstate it somewhat:

- TIAA RE which Swensen is on the Board is effectively an example of how institutional investors access the asset class- ie as Limited Partners in a fund which holds buildings directly

I think the argument is really how 'stock like' these are, given these are listed companies. And I think that 2008 suggests they are stock like, in the worst way, when it really hits the fan. They are not giving you the diversification benefits that you seek.

CRE is in theory lower risk than the stocks of companies-- tenancies are in effect a form of company debt (companies need premises in which to operate), and so bond like. In addition, rental agreements usually rise with inflation, so you have a degree of inflation protection as well. Buildings depreciate, but land prices tend to rise with inflation.

So one of the main attractions of CRE investing is higher correlation with inflation than for ordinary stocks. Conversely they should have lower expected returns (lower volatility).


To my mind, the Swensen and Malkiel levels (up to 20% REITs) will impose a level of volatility on portfolios that is not what most investors seek. REITs move up and down with the credit cycle, and the moment of danger for most individual investors is what happened with/ during 2008, ie a credit cycle blowup.

5-10% is probably not outrageously harmful, and may pay some diversification benefits. However you have significant tax issues to address.

International REITs the problem is there are not many real REITs-- most are REOCs, Real Estate Operating Companies, ie companies like any other.
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Re: REITS as a separate asset class?

Post by nisiprius »

When I held TIAA Real Estate it seemed to me that that particular vehicle was probably different enough from stocks to belong in its own category.

Briefly, I held a small amount of Vanguard REIT Index, based on Burton Malkiel's enthusiasm for same and a vague notion that it could have the same role in my portfolio as TIAA Real Estate. :oops: Malkiel gives it it's own wedge in his pie charts.

Speaking only of the Vanguard REIT Index Fund, VGSIX, my feeling now is that this particular mutual fund does not belong in a separate asset class. It's Just Another Stock Subclass. Like many narrower subclasses, it displays higher return, higher volatility, and so-called "diversification" benefits. When I actually look at the chart, what I see with my naked eyeball is one great shining moment, two years long, 1999-2001, when it would have counteracted the fall of the total market--immediately preceded by two years when it hurt. For that four-year period it did a swell job of "diversification," but the rest of the time, what is it? Just a magnified copy of the total market.

It's my impression that a lot of stock subclasses that are touted as "diversifiers" are that way. The "diversifier" claims are not totally empty, but when you look for actual time periods where it moved oppositely from stocks and really helped smooth a portfolio, those times are rare. Like active-fund apparent outperformance, it's bursty. And it sure as heck didn't help at all when it really mattered. It's just stock. It's not identical in behavior to the stock market as a whole, but you could say the same thing about other narrow sectors as well.

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Re: REITS as a separate asset class?

Post by JohnniNielsen »

Just a few of my own thoughts..

The current Risk-On, Risk-Off, market regime makes all Risky Assets behave the same. So our Alocation model, must be something like a Pair-Switching model, dynamically switching from Riskless Assets like Nominal Bonds in Risk-Off regimes, to Diversified Allocation models in a Risk-on Regime.

However to create a robust diversification, I think we need to look at underlying Return Drivers and not Asset classes. REITs can be both exchange listed and unlisted, but they share the same return driver as Equities and Corporate Bonds. That is Market Sentiment in the form of Yield-compression in the short run, and Economic Growth in the long run.

However unlisted REITs are Stale priced assets with less Step-wise Volatility, because the price discovery is not don’t done through the market, but based on Valuations. If an Investor can live with less liquidity, they may help lower Volatility and Drawdowns in his portfolio.

There is also another potential reason. Investing into different Investment Assets, should not be looked at in isolation from those future Liabilities we seek to save for.

If you as an investor want to buy a house in Florida 10 years from, now, it makes sense (if the Yield is attractive) to consider buying a Florida focused Residential-REIT fund, simply because it correlates with such a future Liability.
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Re: REITS as a separate asset class?

Post by zaboomafoozarg »

JohnniNielsen wrote:Just a few of my own thoughts..

The current Risk-On, Risk-Off, market regime makes all Risky Assets behave the same. So our Alocation model, must be something like a Pair-Switching model, dynamically switching from Riskless Assets like Nominal Bonds in Risk-Off regimes, to Diversified Allocation models in a Risk-on Regime.

However to create a robust diversification, I think we need to look at underlying Return Drivers and not Asset classes. REITs can be both exchange listed and unlisted, but they share the same return driver as Equities and Corporate Bonds. That is Market Sentiment in the form of Yield-compression in the short run, and Economic Growth in the long run.

However unlisted REITs are Stale priced assets with less Step-wise Volatility, because the price discovery is not don’t done through the market, but based on Valuations. If an Investor can live with less liquidity, they may help lower Volatility and Drawdowns in his portfolio.

There is also another potential reason. Investing into different Investment Assets, should not be looked at in isolation from those future Liabilities we seek to save for.

If you as an investor want to buy a house in Florida 10 years from, now, it makes sense (if the Yield is attractive) to consider buying a Florida focused Residential-REIT fund, simply because it correlates with such a future Liability.
... :confused
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