Why Not REIT's?

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dividendinvestor91
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Why Not REIT's?

Post by dividendinvestor91 » Mon Jul 17, 2017 4:33 am

Could somebody advise me on why REIT's have the preconception that they are volatile and risky?
From everything I've researched on them, they've locked in better performance than all large-cap/small-cap stocks year after year.
Also, REIT's are governed by government agencies with strict guidelines, and they pay out at least 90% of their profits as dividends.

Am I missing something? I don't see the risk besides the obvious economic downtrends, real estate related government policies affects, etc.

Could somebody who is more proficient on REIT's explain to me what I should be on the lookout for before I invest capital into some REIT stocks?

Thanks,

Andrew

MotoTrojan
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Re: Why Not REIT's?

Post by MotoTrojan » Mon Jul 17, 2017 5:30 am

dividendinvestor91 wrote:Could somebody advise me on why REIT's have the preconception that they are volatile and risky?
From everything I've researched on them, they've locked in better performance than all large-cap/small-cap stocks year after year.
Also, REIT's are governed by government agencies with strict guidelines, and they pay out at least 90% of their profits as dividends.

Am I missing something? I don't see the risk besides the obvious economic downtrends, real estate related government policies affects, etc.

Could somebody who is more proficient on REIT's explain to me what I should be on the lookout for before I invest capital into some REIT stocks?

Thanks,

Andrew
2008 (for the record I do not consider myself proficient on REITs)

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TomatoTomahto
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Re: Why Not REIT's?

Post by TomatoTomahto » Mon Jul 17, 2017 5:38 am

Welcome to the forum!

I gather from your username that you're not among them, but there are people who don't think paying a lot of dividends is a plus. Additionally, I don't own REITs for the same reason I don't own metals, timberland, etc.; I'm fine without them.

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fire5soon
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Re: Why Not REIT's?

Post by fire5soon » Mon Jul 17, 2017 5:44 am

Tax rules can change. Up until a few years ago REIT's had to pay out 95%, not just 90%. This change alone gave me serious pause regarding REIT's.
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jbranx
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Re: Why Not REIT's?

Post by jbranx » Mon Jul 17, 2017 5:59 am

Reit payouts are very low compared to historical, e-commerce is killing a lot of malls, and mall visits are down even in some of the very popular ones. Reits just became the 11th sector in the Global Industry Classification System (S&P and MSCI joint venture) testifying that they are not an undiscovered asset class by any means. Dividend growth in reits, which took off in the early nineties and continued robustly into this century, will be very low compared to the past. The reit dividends do not qualify for the low tax rates of other dividend stocks either. Neither do reit preferred stocks.

Since they pay out 90% of their gains, they have to borrow heavily to grow; not a good situation when interest rates are expected to rise globally as central banks withdraw stimulus.

If you want to research reit ETF funds, VNQ and VNQI from Vanguard are regarded as the best ones.

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Re: Why Not REIT's?

Post by oldcomputerguy » Mon Jul 17, 2017 6:21 am

dividendinvestor91 wrote:Could somebody advise me on why REIT's have the preconception that they are volatile and risky?
Well, perhaps because they are. Morningstar reports the 10-year standard deviation of Vanguard's REIT Index Admiral Shares fund (VGSLX) as 25.45, much higher than VTSAX's 15.72 or even VSIAX Small-cap Value Index Admiral's 20.0. Even excluding the 2008 market downturn nine years ago (which hit real estate very hard) and only looking at the past five, VSIAX Small-cap Value had a standard deviation of 12.37, VTSAX Total Market came in at 9.79, and VGSLX REIT fund came in higher than both at 13.79.

Also, REIT funds are concentrated in a particular sector of the market, so by definition they are less diversified than (say) a total-stock-market fund such as VTSAX.
From everything I've researched on them, they've locked in better performance than all large-cap/small-cap stocks year after year.
Which reinforces the position that they are riskier. Risk and reward go hand in hand.
Also, REIT's are governed by government agencies with strict guidelines, and they pay out at least 90% of their profits as dividends.
Which has serious tax consequences. Unlike most other stocks and stock funds, REIT dividends are never qualified, which means they are taxed at your higher marginal rate rather than at the long-term capital rate applied to qualified dividends.

I don't personally hold any REITs other than those included in total-market, but many do tilt that way. But if I were you, I'd be prepared for more risk and volatility.
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Re: Why Not REIT's?

Post by sschoe2 » Mon Jul 17, 2017 7:44 am

jbranx wrote:Reit payouts are very low compared to historical, e-commerce is killing a lot of malls, and mall visits are down even in some of the very popular ones. Reits just became the 11th sector in the Global Industry Classification System (S&P and MSCI joint venture) testifying that they are not an undiscovered asset class by any means. Dividend growth in reits, which took off in the early nineties and continued robustly into this century, will be very low compared to the past. The reit dividends do not qualify for the low tax rates of other dividend stocks either. Neither do reit preferred stocks.

Since they pay out 90% of their gains, they have to borrow heavily to grow; not a good situation when interest rates are expected to rise globally as central banks withdraw stimulus.

If you want to research reit ETF funds, VNQ and VNQI from Vanguard are regarded as the best ones.
I am also worried about retail as well.

I am planning on opening a Roth IRA in addition to my 401k and and considering VNQ. It wouldn't be a big % of my holdings like <2%. However it is 18% retail.

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aristotelian
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Re: Why Not REIT's?

Post by aristotelian » Mon Jul 17, 2017 7:58 am

Concentrating in any sector is inherently riskier than owning the total stock market.

munemaker
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Re: Why Not REIT's?

Post by munemaker » Mon Jul 17, 2017 8:09 am

Personal Capital recommended that I put 5% of my portfolio in domestic and international REITs. I wish I could justify adding REITs to my portfolio in a retirement account.

With so many malls and retail being depressed, and in a rising interest rate environment, it just doesn't seem to make sense to me. I also reviewed history of some REITs in Morningstar and did some back testing using Portfolio Visualizer. Yes, past performance is not an indicator of the future, but when I combine past performance with the outlook for retail and the strong possibility of rising interest rates, I can't get there.

I looked at investing in REITs and decided not to at this time. If I invested in REITs, I would try to stay away from mall real estate and limit it to 5% of my portfolio.

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Re: Why Not REIT's?

Post by JimmyD » Mon Jul 17, 2017 8:20 am

With all the negative talk about traditional retail and the lousy performance of late, I've been loading up on REITs, but I'm also 25 years out from retirement.

They have been and will continue to be 10% of my portfolio. When I get back to that 10% mark, contributions will be allocated elsewhere.

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Re: Why Not REIT's?

Post by alex_686 » Mon Jul 17, 2017 8:46 am

aristotelian wrote:Concentrating in any sector is inherently riskier than owning the total stock market.
No. The odd thing about diversification is that if one adds a risky asset class with a low correlation to the rest of your portfolio you get a less risky portfolio.

REITs, unlike any other sector, has a prescient low correlation with the rest of the market. Legally they are equities. However, as they say, if it walks like a duck and quakes like a duck it is a duck. REITs don't walk or quakes like the rest of the market. I believe this is because of the weird tax rules around REITs. It keeps their focus pure.
jbranx wrote:Reit payouts are very low compared to historical, e-commerce is killing a lot of malls, and mall visits are down even in some of the very popular ones. Reits just became the 11th sector in the Global Industry Classification System (S&P and MSCI joint venture) testifying that they are not an undiscovered asset class by any means.
Jbranx, do you know what percentage of REITs are retail? I thought it was reality small but it has been a while since I have check out the numbers.

Also, I would contest a little bit about REITs getting a new sector. REITs had their own sub-sector under financial services, if I recall correctly. Mortgage REITs are still a sub-section in finance. That sub-sector was promoted to its own sector because everybody was treating it as it own sector for a long time. It had it own sector funds, it own indexes, etc. I will agree that it was not a undiscovered thing.

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Re: Why Not REIT's?

Post by jbranx » Mon Jul 17, 2017 9:08 am

alex_686 wrote:
aristotelian wrote:Concentrating in any sector is inherently riskier than owning the total stock market.
No. The odd thing about diversification is that if one adds a risky asset class with a low correlation to the rest of your portfolio you get a less risky portfolio.

REITs, unlike any other sector, has a prescient low correlation with the rest of the market. Legally they are equities. However, as they say, if it walks like a duck and quakes like a duck it is a duck. REITs don't walk or quakes like the rest of the market. I believe this is because of the weird tax rules around REITs. It keeps their focus pure.
jbranx wrote:Reit payouts are very low compared to historical, e-commerce is killing a lot of malls, and mall visits are down even in some of the very popular ones. Reits just became the 11th sector in the Global Industry Classification System (S&P and MSCI joint venture) testifying that they are not an undiscovered asset class by any means.
Jbranx, do you know what percentage of REITs are retail? I thought it was reality small but it has been a while since I have check out the numbers.

Also, I would contest a little bit about REITs getting a new sector. REITs had their own sub-sector under financial services, if I recall correctly. Mortgage REITs are still a sub-section in finance. That sub-sector was promoted to its own sector because everybody was treating it as it own sector for a long time. It had it own sector funds, it own indexes, etc. I will agree that it was not a undiscovered thing.
Retail is the larges sector at about 19%. The other one to be concerned about is the health care sector given the changes in reimbursements that may be coming. I've invested in reits since they became public, had heavy concentrations in Realty Income--kind of the Berkshire Hathaway of reits in terms of value approach--and others like Duke Realty and many others. Reit preferreds like Public Storage. But I got out of all of them when the fundamentals began to change. Only own them now as part of VTI. Maybe they are a contrarian bet but i don't see that in the fundamentals. NYC commercial real estate is overbuilt and prices are starting to decline there. It's always the best canary in my experience. I'm 71, so with a long horizon you may have great results. Buffet just bought the Sears store reit but it was quite depressed. Green Street Advisers publishes net asset values on reits, so you might study those. As well, Cohen and Steers is a reit specialist. They have a some closed end funds as well as open end and an ETF. RNP is a "balanced" and leveraged closed end that buys both reit common and preferred and has a high yield, and I think is still at a discount. You can check M'star or cefconnect.com to see the discount.

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Re: Why Not REIT's?

Post by munemaker » Mon Jul 17, 2017 9:10 am

aristotelian wrote:Concentrating in any sector is inherently riskier than owning the total stock market.
By owning total stock market, you are concentrating in the technology sector as it has the most market weight, right?

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Re: Why Not REIT's?

Post by MrNewEngland » Mon Jul 17, 2017 9:12 am

oldcomputerguy wrote:
Which has serious tax consequences. Unlike most other stocks and stock funds, REIT dividends are never qualified, which means they are taxed at your higher marginal rate rather than at the long-term capital rate applied to qualified dividends.
I get confused by this.

I own some VNQ, but it's in my Roth IRA. Will these tax consequences have an effect on me when I withdraw?

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Re: Why Not REIT's?

Post by MindTheGAAP » Mon Jul 17, 2017 9:15 am

MrNewEngland wrote:
oldcomputerguy wrote:
Which has serious tax consequences. Unlike most other stocks and stock funds, REIT dividends are never qualified, which means they are taxed at your higher marginal rate rather than at the long-term capital rate applied to qualified dividends.
I get confused by this.

I own some VNQ, but it's in my Roth IRA. Will these tax consequences have an effect on me when I withdraw?
No tax consequences. The only place to hold REITs (in my opinion) is in a tax advantaged account (Traditional or Roth).
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Re: Why Not REIT's?

Post by jbranx » Mon Jul 17, 2017 9:19 am

MrNewEngland wrote:
oldcomputerguy wrote:
Which has serious tax consequences. Unlike most other stocks and stock funds, REIT dividends are never qualified, which means they are taxed at your higher marginal rate rather than at the long-term capital rate applied to qualified dividends.
I get confused by this.

I own some VNQ, but it's in my Roth IRA. Will these tax consequences have an effect on me when I withdraw?
No, you're fine. However, as non-qualified dividends in a taxable account you would be paying at your highest tax rate on VNQ dividends. IRS views the non-taxable reit's already generous benefits as not deserving the same treatment as regular corporations. There is no classification of the withdrawals from an IRA; once you are 70.5 you must take the RMD's and pay at your regular federal and state rates on everything withdrawn.
Last edited by jbranx on Mon Jul 17, 2017 9:21 am, edited 1 time in total.

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Re: Why Not REIT's?

Post by F150HD » Mon Jul 17, 2017 9:21 am

unclear why some folks keep referencing 'malls', not all REITS are about malls and shopping.

suggest the OP read up on how REITS are taxed.

OP didn't state if this was in taxable or tax-deferred. The 'return of capital' and cost basis seems tricky to me personally in taxable.

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Re: Why Not REIT's?

Post by aristotelian » Mon Jul 17, 2017 9:28 am

munemaker wrote:
aristotelian wrote:Concentrating in any sector is inherently riskier than owning the total stock market.
By owning total stock market, you are concentrating in the technology sector as it has the most market weight, right?
Sort of. You are owning the total stock market. Tech may be dominant now, but that may change over time. You are owning every stock according to its market weight.

If you were concerned about the risk of tech, the solution would be to overweight everything except tech, which would include REIT.

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Re: Why Not REIT's?

Post by BigMoneyNoWhammies » Mon Jul 17, 2017 9:56 am

jbranx wrote:Reit payouts are very low compared to historical, e-commerce is killing a lot of malls, and mall visits are down even in some of the very popular ones. Reits just became the 11th sector in the Global Industry Classification System (S&P and MSCI joint venture) testifying that they are not an undiscovered asset class by any means. Dividend growth in reits, which took off in the early nineties and continued robustly into this century, will be very low compared to the past. The reit dividends do not qualify for the low tax rates of other dividend stocks either. Neither do reit preferred stocks.

Since they pay out 90% of their gains, they have to borrow heavily to grow; not a good situation when interest rates are expected to rise globally as central banks withdraw stimulus.

If you want to research reit ETF funds, VNQ and VNQI from Vanguard are regarded as the best ones.
All of the above. The extended low interest rate environment has been advantageous to REITS for the last decade or so by lowering their future debt obligations and allowing increased cash flow for dividends, but that is coming to an end as the Fed expects steady increases of rates for the near term. They're also a huge hassle from a tax perspective if you're unfortunate enough to hold them in a taxable account. there are certainly REIT options that avoid traditional commercial real estate and plenty of people have a portion of their portfolio dedicated to REITs as a passive income investment, but my guess is most people on this forum would advise you to avoid them due to their sensitivity to interest rate increases and tax disadvantages. As rates continue to go up, bonds will become more attractive as an income option once again; I'd look into that sector over a REIT for passive income in the next few years.

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Re: Why Not REIT's?

Post by tennisplyr » Mon Jul 17, 2017 10:07 am

munemaker wrote:
aristotelian wrote:Concentrating in any sector is inherently riskier than owning the total stock market.
By owning total stock market, you are concentrating in the technology sector as it has the most market weight, right?
Overweighting not concentrating.
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Re: Why Not REIT's?

Post by nedsaid » Mon Jul 17, 2017 11:49 am

What are the reasons you are interested in REITs? The why question is really important.

The right answer is that you are looking for an asset class with stock like returns with sometimes low correlation to the US Stock Market. The wrong answer is that you want the dividends. Another thing to consider are the valuations of REITs which right now look expensive. The valuation question has cooled my enthusiasm for REITs. I sold about 20% of my REITs and am keeping the rest. I am not buying more.

Hopefully, you aren't just chasing dividends and keep in mind that the yield chase has been going full bore for almost nine years now. People know that interest rates are low. The answer isn't to chase dividend yield even harder. What I am saying is to buy these for good reasons and to have realistic expectations. REITs are perceived as volatile and risky because they ARE volatile and risky. I have seen these fluctuate as much as 10% in one day. My suspicion is that you want to chase yield and hot performance. This is a prescription for disappointment.

My recommendation is that if you want to buy these, limit them to at most 10% of your portfolio, probably 5% would be better. There might be a diversification benefit but my belief is that REIT returns from here will be muted. I would not load up on these. My enthusiasm for these have cooled. You might find better valuations with International Real Estate.
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Re: Why Not REIT's?

Post by flamesabers » Mon Jul 17, 2017 12:02 pm

dividendinvestor91 wrote:Am I missing something? I don't see the risk besides the obvious economic downtrends, real estate related government policies affects, etc.
I think something to consider is Vanguard's REITs, like other sector stocks don't have a particularly large number of stocks. For instance, Vanguard's REIT funds have a total of 157 stocks, versus the Total Stock Market which has 3,591. When REITs have a downturn in the market, you're really going to see it in the value of your REIT fund. If you can stay the course no matter what, go ahead and buy REITs. If you have doubts about staying through a difficult time in the market, sector stock funds might not be for you.

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Re: Why Not REIT's?

Post by Pajamas » Mon Jul 17, 2017 12:13 pm

REITs must distribute at least 90% of taxable income. The trust structure is designed to pass through earnings from real estate and real estate finance operations without taxing them at the corporate level.

There are many different kinds of REITs, including equity, mortgage, and hybrid; and equity REITs can specialize in anything from farmland to energy infrastructure to senior living facilities.

It would be wrong to describe them all as volatile and risky. Just like other stocks, they vary in terms of volatility and risk, and volatility and risk change over time. There were few places to hide in the 2008-2009 financial crisis.

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Re: Why Not REIT's?

Post by Nowizard » Mon Jul 17, 2017 2:45 pm

REITS are often recommended for larger portfolios. They are volatile, and they are definitely best held in tax deferred areas of your portfolio. If you can stand the volatility, you would have been nicely rewarded in recent years. Some also say they provide additional diversification and often diverge from the larger market, though I am not certain of the accuracy of that statement. The REIT index does happen to be the lowest performing fund in our current portfolio (YTD) with the exception of a ST bond fund, and we would be adding small amounts except that it has kept rising above the percentage of our total portfolio in recent years requiring withdrawals as part of a MRD.

Tim

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Re: Why Not REIT's?

Post by alex_686 » Mon Jul 17, 2017 3:01 pm

jbranx wrote:Retail is the larges sector at about 19%.
For myself, that is not a large percentage overall.

The nice things about REITs in this situation is that they distribute 90% of their earnings and don't reinvest them back into the property. I can see retail as a nice "zombie" play. Malls in slow decay, the REIT squeezing every last ounce of revenue from them, to be finally being sold to another development REIT, to be plowed under and redeveloped.

As an aside, this is a good reason why one should not dividend reinvest. Dividends are not free money, a low risk return, or always positive. Some companies do self dissolve by paying out dividends.

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Re: Why Not REIT's?

Post by Valuethinker » Mon Jul 17, 2017 3:52 pm

dividendinvestor91 wrote:Could somebody advise me on why REIT's have the preconception that they are volatile and risky?
From everything I've researched on them, they've locked in better performance than all large-cap/small-cap stocks year after year.
Also, REIT's are governed by government agencies with strict guidelines, and they pay out at least 90% of their profits as dividends.

Am I missing something? I don't see the risk besides the obvious economic downtrends, real estate related government policies affects, etc.

Could somebody who is more proficient on REIT's explain to me what I should be on the lookout for before I invest capital into some REIT stocks?

Thanks,

Andrew
Run the chart on REITs 2008-09.

Underperformed the market by about 20% I believe.

That was a bone crunching ride. And I don't see evidence of low correlation in that. I see high Beta, in fact. A sort of super financial services sector.

If inflation picks up (above market expectations) then REITs will probably do better than stocks. If not, probably not.

Note we are talking property REITs. Mortgage REITs are not in the Vanguard Index fund, and I see no reason for investors to invest in them, and certainly not overweighting the market weight in them.

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Re: Why Not REIT's?

Post by Valuethinker » Mon Jul 17, 2017 3:53 pm

Pajamas wrote:REITs must distribute at least 90% of taxable income. The trust structure is designed to pass through earnings from real estate and real estate finance operations without taxing them at the corporate level.

There are many different kinds of REITs, including equity, mortgage, and hybrid; and equity REITs can specialize in anything from farmland to energy infrastructure to senior living facilities.

It would be wrong to describe them all as volatile and risky. Just like other stocks, they vary in terms of volatility and risk, and volatility and risk change over time. There were few places to hide in the 2008-2009 financial crisis.
From memory, the US REIT index fund underperformed the market index fund by about 20% during 2008-09. That is volatility?

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Re: Why Not REIT's?

Post by ruralavalon » Mon Jul 17, 2017 3:56 pm

Welcome to the forum :) .
dividendinvestor91 wrote:Could somebody advise me on why REIT's have the preconception that they are volatile and risky?
That's because they are more volatile and risky.

divideninvestor91 wrote:From everything I've researched on them, they've locked in better performance than all large-cap/small-cap stocks year after year.
Do some more research, in the 2008 crash Vanguard REIT Index Fund dropped far more than Vanguard Total Stock Market Index Fund.

dividendinvestor91 wrote:Also, REIT's are governed by government agencies with strict guidelines, and they pay out at least 90% of their profits as dividends.

Am I missing something? I don't see the risk besides the obvious economic downtrends, real estate related government policies affects, etc.
True enough, they do pay high dividends.

divdendinvestor91 wrote: Could somebody who is more proficient on REIT's explain to me what I should be on the lookout for before I invest capital into some REIT stocks?

Thanks,

Andrew
I would never consider an individual REIT stock. I think it's Ok to use a Fund like Vanguard REIT Index Fund as long as you recognize the risk and volatility. The volatility presents an opportunity to benefit from rebalancing if held in an IRA or 401k, and as long as you are very disciplined.
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Re: Why Not REIT's?

Post by Robert T » Mon Jul 17, 2017 4:00 pm

.
FWIW – some analysis I did on REITs that may be of interest to some.

“Over the long haul, what matters is factor exposure and expense.” – Bill Bernstein [2002]

Factor exposure

REITs provide a smaller cap and value tilt. For example, here are the mkt, size and value exposures/tilts from the Fama-French three factor model on the FTSE NAREIT Equity REIT Index. These imply / are similar to a MidCap Value Index.

January 1972 to June 2017
  • 0.02 = Alpha
    0.69 = Market
    0.36 = Size
    0.60 = Value
On average, the REIT index ‘captured’ 69% of the equity premium, 36% of the size premium, and 60% of the value premium over this period, with a small 0.02% monthly/ 0.21% annual residual not explained by the FF three factor model.

Over this period the average monthly equity premium = 0.55%, size premium = 0.16%, and value premium = 0.36%.

Using the shares of these premiums ‘captured’ by the REIT index + alpha (the residual not explained by the model) gives:

0.69*0.55 + 0.36*0.16 + 0.60*0.36 + 0.02 = 0.67 = average monthly return of the FTSE NAREIT Equity REIT Index over this period.

What about low explanatory power?

The R^2 of the FF three factor model over this period was 0.5 meaning that only 50% of the variation in returns of the REIT index was explained by the variation in market, size, and value factors. So while, on average, over the full period there was a small average residual (0.02 alpha), there were large annual variations in actual returns vs. those implied by the FF model coefficients listed above.

Some point to this low explanatory power as justification for inclusion of REITs i.e. that it adds diversification beyond simply factor exposure, beyond that of a mid-cap value index. Indeed the correlations of the annual residuals (actual annual REIT returns minus return implied by the factor exposure coefficients) with annual equity, size, and value premiums are all 0.

Does this provide much diversification benefit?

To test this, I used a 75:25 stock:bond portfolio (similar to my own), and I added the REIT index to a Mid Cap Value Index. As per above, the REIT index has the same/similar factor exposure to a Mid Cap Value Index.

Here are the results:

1972-2016: Annualized Returns (%) / Standard Deviation
  • P1 = 12.2 / 14.8 = 75:25 US MidCap Value:5yr T-Notes
    P2 = 12.2 / 14.8 = 56:19:25 US MidCap Value:5yr T-Notes:REITs*

    * This simply adds a 25% REIT allocation to P1. The earlier FF results show a 0.69 mkt load on the REIT index indicating it is about 70% equity: 30% bond which is close to the 75:25 equity bond allocation of P1, so simply adding REITs implies taking 75% of the REIT allocation from equities and 25% from bonds. The reason for using 25% REITs was to test a large enough allocation to have a meaningful impact. Using smaller allocation provides similar results.
The above results are not a typo – P1 and P2 had the same return and standard deviation i.e. no diversification benefit. What happened to the diversification benefit of the annual variation in REIT returns not explained by the variation in factor exposure? Perhaps is was offset by the ‘loss’ in some diversification benefit from reducing the term exposure of fixed income between P1 and P2. The fixed income exposure of P2 is composed of both 19% 5yr T-Notes and about 6% from T-bills (the latter derived from the FF3F model). This could be adjusted for by extending the term exposure beyond 5-yr T-notes for the 19% allocation in P2 that when combined with T-bills gives the same term exposure as 5-yr T-notes – but this becomes very complex for likely very small, if any, benefits.

FWIW - I did a similar exercise with a global portfolio.

1973-2016: Annualized Returns (%) / Standard Deviation / Sharpe Ratio
  • P3 = 12.2 / 13.9 / 0.59 = 75:25 DFA [Global] Equity Balanced:5yr T-Notes
    P4 = 12.3 / 14.0 / 0.59 = 62:20:18 DFA [Global] Equity Balanced:5yr T-Notes:REITS**

    ** As the DFA [Global] Equity Balanced portfolio already has an explicit 10% REIT allocation, only an 18% (17.5% to be precise) additional REITs allocation was needed to increase the portfolio REIT allocation to 25%.
While P4, with a 25% REIT overall allocation, had a marginally higher return, it also had a higher standard deviation with no difference in Sharpe Ratio ie. no diversification benefit of adding REITs to this global portfolio.

Expense

Not much to say, other than the expense ratios of MidCap Value funds are similar to REIT funds, but the latter is less tax-efficient. I would just note that MidCap Value funds tend to already have some exposure to REITs.

Bottom line

Adding REITs to a portfolio with similar tilts to size and value has added no/little diversification benefit (even though about half the variation in REITs returns were not explained by variations in the equity, size, and value premiums – the ‘unexplained’ variation did not provide any/much meaningful diversification benefit – at least in the two examples above).

I would just note that the result is likely different if adding REITs to a market portfolio with no tilt to smaller caps or value stocks. The diversification benefit of REITs would likely be from its size and value tilts.

David Swensen’s sample portfolio in his Unconventional Success book included a 20 percent REIT allocation to a ‘market’ portfolio. Interestingly if you use his capital market assumptions (expected returns and correlations) in his book Pioneering Portfolio Management, a mean-variance optimization of a portfolio of US stocks, foreign stocks, emerging market stocks, US bonds, and REITs gives a similar allocation to his book with about a 20 percent allocation to REITs. This is what induced me to take another look at REITs.

I have a global small cap and value tilted portfolio with 75% in stocks, 25% in bonds. I don’t have a separate allocation to REITs, and don’t intend to add one now (as per the above analysis).

Robert
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Re: Why Not REIT's?

Post by AlohaJoe » Mon Jul 17, 2017 4:04 pm

alex_686 wrote:REITs don't walk or quakes like the rest of the market.
A Carhart 4-factor regression analysis shows that REITs have no statistically significant alpha. In other words, they walk and quack exactly like the market, assuming you buld a replicating portfolio of the appropriate factors.
Last edited by AlohaJoe on Mon Jul 17, 2017 4:16 pm, edited 1 time in total.

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Re: Why Not REIT's?

Post by Valuethinker » Mon Jul 17, 2017 4:08 pm

jbranx wrote:
Retail is the larges sector at about 19%. The other one to be concerned about is the health care sector given the changes in reimbursements that may be coming. I've invested in reits since they became public, had heavy concentrations in Realty Income--kind of the Berkshire Hathaway of reits in terms of value approach--and others like Duke Realty and many others. Reit preferreds like Public Storage. But I got out of all of them when the fundamentals began to change. Only own them now as part of VTI. Maybe they are a contrarian bet but i don't see that in the fundamentals. NYC commercial real estate is overbuilt and prices are starting to decline there. It's always the best canary in my experience. I'm 71, so with a long horizon you may have great results. Buffet just bought the Sears store reit but it was quite depressed. Green Street Advisers publishes net asset values on reits, so you might study those. As well, Cohen and Steers is a reit specialist. They have a some closed end funds as well as open end and an ETF. RNP is a "balanced" and leveraged closed end that buys both reit common and preferred and has a high yield, and I think is still at a discount. You can check M'star or cefconnect.com to see the discount.
We hold it here that you can't outperform markets-- they are efficient and in aggregate know more than any one of us can know (without insider information).

And yet. I'm with you. Commercial Real Estate is a very cyclical sector, and the cycles are long. I remember Texas (and Calgary) in the early 1980s, the post S&L debacle, the New England (and Toronto) commercial RE market in the early 1990s (a building was started in Toronto in 1989, it sat, a hole int the ground, and was finally completed around 2006). A colleague part owned an office building in Calgary (inheritance) which was empty in 1981, and empty in 1994 when I worked with him. I also remember Canary Wharf going broke (London, early 1990s). And what might have happened in London to commercial RE if there had not been a c £80bn government bailout of the financial services sector in 2008-09 (plus US bailout of Wall Street banks).

So I look at cap rates (yields in UK-speak). And they are low-- probably back down around 4% in London (which is where they were when the bubble peaked in 2007). And the nature of office demand has changed-- companies want more flexibility now, and are able to reduce their demand for office space quite quickly. Leases are shorter.

Retail? We all know what is happening to the North American mall, structurally. The UK is less "malled" but they are still building some big new ones. I see the US malls being closed, converted to other purposes. We are seeing the death of the "anchor tenant" the department store-- Amazon has killed the department store (except at the high end). Rental residential RE is almost unknown here (it's all owned by individuals owning say 2-20 units, mostly) but in the US I would guess apartment REITs are pretty solid due to demographics and the long term effects of the credit crunch (many will never again get a mortgage). Single Family Home REITs (a couple of PE funds floated them) I don't see the economics-- as Sam Zell noted, the cost of managing such estates is very high compared to apartment REITs.

So I see in CRE these long term trends, and I think the market is more short term than that. Partly due, in this environment, to "yield chasing". CRE has always been cyclical, and the cycles are *long*-- boom to bust to boom in c. 15 years*. It's a long game, winners are those who are very patient, and deleverage before the periodic busts.

When REITs were screaming bargains (in retrospect) was when discounts to NAV were double digits in the late 90s, yields were (from memory) 5-8%. We are nowhere near that now. OK everything has been pushed up by low interest rates, but you can still buy stocks at 3-3.5% dividend yield (including buybacks). That's more or less the level of REITs?

Where I will be wrong is if inflation is significantly above expectations. Because leases tend to reset with inflation, REITs are a superior inflation hedge to ordinary stocks.

* Jon Sterman wrote a textbook on Systems Dynamics Modelling (Donella Meadows had the simplest introduction "Thinking in Systems"; this is the Jay Forrester Denis Meadows MIT stuff). In that book, there is a nice description of why commercial RE is cyclical. You have long lags between rising demand and prices producing rising supply (typically 5 years + from inception of a major office building, to its commission), and you have forecasting errors. Thus RE as an industry is always oversupplied or undersupplied (semiconductors has a similar pattern, on a much shorter cycle). The addition of financial leverage means the returns are great on the way up, and the busts correspondingly spectacular on the way down-- this is what brought down the Bank of New England in the early 1990s, and HBOS (now Lloyds) and the Irish banks here in 2008-9 i.e. bad property lending.

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Re: Why Not REIT's?

Post by AlohaJoe » Mon Jul 17, 2017 4:14 pm

Robert T wrote:.
On average, the REIT index ‘captured’ 69% of the equity premium, 36% of the size premium, and 60% of the value premium over this period, with a small 0.02% monthly/ 0.21% annual residual not explained by the FF three factor model.
You'll find using the Carhart 4 factor model with 2 factors for bonds (i.e. 6 factors in total) will remove this alpha. It will actually go to -89bps (albeit with a statistically insignificant t-stat of -0.3)

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Re: Why Not REIT's?

Post by Pajamas » Mon Jul 17, 2017 4:14 pm

alex_686 wrote: The nice things about REITs in this situation is that they distribute 90% of their earnings and don't reinvest them back into the property.


REIT's don't distribute 90% of their earnings. They are required to distribute at least 90% of their taxable income and REITs that own property do use depreciation in their accounting and also maintain and improve their properties as well as buy and sell properties. Many REITs do return capital in their distributions. Even REITs that don't normally do so may include it on occasion when they have sold several properties and not purchased new ones.

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Re: Why Not REIT's?

Post by Earl Lemongrab » Mon Jul 17, 2017 5:29 pm

I have 10% of my stocks in REIT, so about 6% overall. I will note that because an asset class has had good performance over a period doesn't mean that it isn't risky or volatile. In fact, if you expect it to outperform that's pretty much the definition of risky.
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Re: Why Not REIT's?

Post by spdoublebass » Mon Jul 17, 2017 5:56 pm

I have always wondered about REIT's as well. I am a pretty simple and new investor myself.
Robert T wrote:.

I have a global small cap and value tilted portfolio with 75% in stocks, 25% in bonds. I don’t have a separate allocation to REITs, and don’t intend to add one now (as per the above analysis).

Robert
.
I have a very similar portfolio. Thank you for this information.
nedsaid wrote: My recommendation is that if you want to buy these, limit them to at most 10% of your portfolio, probably 5% would be better. There might be a diversification benefit but my belief is that REIT returns from here will be muted. I would not load up on these. My enthusiasm for these have cooled. You might find better valuations with International Real Estate.
Nedsaid, Thank you as always for your great responses. I was wondering, is there any benefit to having REIT's in retirement? Right not I feel comfortable in the amount of REIT"s I own through VT (Total World), VBR (SCV), and VSS (Int. SC). I would be willing to set aside a small percentage on top of that split between VNQ and VNQI. If I split 10% it puts my total up pretty high, but I think 5% wouldn't be a bad idea.
Just to be clear I'm asking that is there an advantage to holding these individually, rather than inside another fund, when you have a less riskier portfolio in retirement. If not, I'll probably just be content with the amount I'm already getting.
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Re: Why Not REIT's?

Post by billthecat » Mon Jul 17, 2017 6:07 pm

Schwab Intelligent Portfolio has a small allocation to REITs, and their asset allocation white paper says:
REITs are considered by many to be an effective hedge against inflation. When looking for inflation protection, it's beneficial to find an asset that moves with inflation (the higher correlation, the better). Lease rates and real estate prices do not immediately adjust to inflation so the benefits of REITs as an inflation hedge may not be apparent when correlations are calculated over short horizons. During the period from 1972 to 2015, the average five-year correlation was 0.37 (shown in Exhibit 6). This suggests that REITs have historically provided better inflation protection than traditional asset classes such as stocks.
I'm a SIP beginner and my portfolio has 5.55% REIT (both domestic and international).

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Re: Why Not REIT's?

Post by nedsaid » Mon Jul 17, 2017 7:15 pm

spdoublebass wrote:I have always wondered about REIT's as well. I am a pretty simple and new investor myself.
Robert T wrote:.

I have a global small cap and value tilted portfolio with 75% in stocks, 25% in bonds. I don’t have a separate allocation to REITs, and don’t intend to add one now (as per the above analysis).

Robert
.
I have a very similar portfolio. Thank you for this information.
nedsaid wrote: My recommendation is that if you want to buy these, limit them to at most 10% of your portfolio, probably 5% would be better. There might be a diversification benefit but my belief is that REIT returns from here will be muted. I would not load up on these. My enthusiasm for these have cooled. You might find better valuations with International Real Estate.
Nedsaid, Thank you as always for your great responses. I was wondering, is there any benefit to having REIT's in retirement? Right not I feel comfortable in the amount of REIT"s I own through VT (Total World), VBR (SCV), and VSS (Int. SC). I would be willing to set aside a small percentage on top of that split between VNQ and VNQI. If I split 10% it puts my total up pretty high, but I think 5% wouldn't be a bad idea.
Just to be clear I'm asking that is there an advantage to holding these individually, rather than inside another fund, when you have a less riskier portfolio in retirement. If not, I'll probably just be content with the amount I'm already getting.
As far as holding REITs in retirement, there might be an advantage if they help reduce the volatility of the total portfolio. You also get the dividends you can harvest for income but for a REIT a part of the yield is, in effect, a return of principal. As I recall, depreciation has a part in this as depreciation is a non-cash expense. Nothing magic about having them in a retirement portfolio. I will continue to hold them.

Is there an advantage to holding REITs individually? I don't think so. It is the individual stock risk thing again. Unless you can pick REITs that outperform the REIT index, it seems like a fool's errand. I have owned a portfolio of individual stocks for many years now having started in 1988. Over the last 15 years, my individual stocks did well but they still trailed the US Total Stock Market Index and the S&P 500 a bit. I haven't been able to beat the averages long term.

I was an "early adopter" of REITs, buying my first REIT fund in January 1998, not long after it became available. It just seemed like a good idea at the time. I was unaware of the academic research that showed that REITs had a bit better performance than the S&P 500 with low correlation. I also owned a Timber REIT for many years and got excellent performance from it. So I was pretty enthusiastic about REITs.

In 2007-2008, I attended a couple of Merriman seminars where I learned about academic research in general and more about REITs. Afterwards, I purchased the Vanguard REIT ETF and another REIT fund through my workplace savings plan. You might say that I was a true believer.

So what happened? Well, the financial crisis of 2008-2009 happened as well as the resulting very, very low interest rates. Investors looking for bond alternatives chased anything that had good yield and that included REITs. Investors chased yield so hard that REITs no longer represent value. Estimates that I have seen of future returns from REITs are maybe 1 percent or 2 percent above the inflation rate, not very much for a volatile asset class. US Stocks are projected to return 4% or 5% above inflation.

I have trimmed both my REIT funds and my Timber REITs by 20% of my holdings. I am keeping the rest, but I am not buying any more either.

You might find better values with International Real Estate. Last I checked, and that was a while ago, International Real Estate was a much better value than US Real Estate. I base this on work by Bill Bernstein and Larry Swedroe. Vanguard has an International Real Estate ETF and you might check into that.
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Re: Why Not REIT's?

Post by nedsaid » Mon Jul 17, 2017 7:41 pm

REITs should be included as part of your stock allocation as REITs really are stocks to begin with. When I used 5% or 10% numbers, this would be percentages of your total portfolio. So if you stock allocation was 70% and you wanted 10% in REITs; your allocation would be 60% stocks, 10% REITs, and 30% bonds and cash. An allocation of anything below 5% of the portfolio would not be meaningful at all and you would probably need 10% to have an effect on both performance and portfolio volatility.
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Re: Why Not REIT's?

Post by abuss368 » Mon Jul 17, 2017 8:46 pm

We have been REIT investors for a long time. Many years ago with individual stocks and now simply the Vanguard U.S. and International REIT Index funds.
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Re: Why Not REIT's?

Post by badbreath » Mon Jul 17, 2017 11:11 pm

Read this from the jlcollinsnh stock series

http://jlcollinsnh.com/2014/05/27/stock ... rom-reits/

May change your mind
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Re: Why Not REIT's?

Post by abuss368 » Tue Jul 18, 2017 1:57 pm

jbranx wrote:Reit payouts are very low compared to historical, e-commerce is killing a lot of malls, and mall visits are down even in some of the very popular ones. Reits just became the 11th sector in the Global Industry Classification System (S&P and MSCI joint venture) testifying that they are not an undiscovered asset class by any means. Dividend growth in reits, which took off in the early nineties and continued robustly into this century, will be very low compared to the past. The reit dividends do not qualify for the low tax rates of other dividend stocks either. Neither do reit preferred stocks.

Since they pay out 90% of their gains, they have to borrow heavily to grow; not a good situation when interest rates are expected to rise globally as central banks withdraw stimulus.

If you want to research reit ETF funds, VNQ and VNQI from Vanguard are regarded as the best ones.
Hi jbranx -

True and good summary but this is only one half of the current trend. While retail is under pressure, industrial REITs are doing well. As more and more companies such as Amazon focus on distribution as a result of the shift to online purchasing, the industrial sector appears to be in growth mode.

There is always a bull market somewhere.
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Re: Why Not REIT's?

Post by nisiprius » Tue Jul 18, 2017 8:31 pm

dividendinvestor91 wrote:...Could somebody advise me on why REIT's have the preconception that they are volatile and risky?...
Because they were volatile and risky in 2008-2009, when the value of stocks in general was cut in half (VTSMX, Vanguard Total Stock Market Index Fund, blue) while the value of REITS (VGSIX, Vanguard REIT index fund, orange) was cut down to about a third of its former value. A third. I personally happened to be holding a big chunk of VTSMX and a little chunk of VGSIX at the time, and the difference was both obvious and memorable.

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Re: Why Not REIT's?

Post by abuss368 » Tue Jul 18, 2017 9:41 pm

nisiprius wrote:
dividendinvestor91 wrote:...Could somebody advise me on why REIT's have the preconception that they are volatile and risky?...
Because they were volatile and risky in 2008-2009, when the value of stocks in general was cut in half (VTSMX, Vanguard Total Stock Market Index Fund, blue) while the value of REITS (VGSIX, Vanguard REIT index fund, orange) was cut down to about a third of its former value. A third. I personally happened to be holding a big chunk of VTSMX and a little chunk of VGSIX at the time, and the difference was both obvious and memorable.

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That was a great opportunity to rebalance and stay the course!
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Re: Why Not REIT's?

Post by Valuethinker » Wed Jul 19, 2017 2:58 am

abuss368 wrote:
nisiprius wrote:
dividendinvestor91 wrote:...Could somebody advise me on why REIT's have the preconception that they are volatile and risky?...
Because they were volatile and risky in 2008-2009, when the value of stocks in general was cut in half (VTSMX, Vanguard Total Stock Market Index Fund, blue) while the value of REITS (VGSIX, Vanguard REIT index fund, orange) was cut down to about a third of its former value. A third. I personally happened to be holding a big chunk of VTSMX and a little chunk of VGSIX at the time, and the difference was both obvious and memorable.

Image
That was a great opportunity to rebalance and stay the course!
Had we turned into the next Japan you would not feel that way.

It's not a given that Commercial Real Estate recovers in the short to medium term-- I have seen busts that lasted 10-15 years.

Note: office rents in the City of London were around £50 in 2008 before the Crash, the same level as they were in 1990 at the time of the previous property slump (which lasted most of the 1990s).

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Re: Why Not REIT's?

Post by nisiprius » Wed Jul 19, 2017 6:15 am

abuss368 wrote:...That was a great opportunity to rebalance and stay the course!...
Perhaps it was--certainly it was in hindsight--but I was addressing the question of "volatile and risky."

They were "volatile and risky." The fact that people who, for whatever reasons, bought it near the bottom, were rewarded, doesn't change the fact that they were risky. In this case, they were rewarded for taking that risk, but the risk was there.
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Re: Why Not REIT's?

Post by nisiprius » Wed Jul 19, 2017 6:20 am

Valuethinker wrote:...It's not a given that Commercial Real Estate recovers in the short to medium term-- I have seen busts that lasted 10-15 years...
This is residential, not commercial real estate, but it's an example of a real estate bust that lasted almost a century.

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Re: Why Not REIT's?

Post by harvestbook » Wed Jul 19, 2017 4:37 pm

I have 5 percent of my stock portfolio in US REITS and 5 percent in global REITS as suggested by Paul Merriman. I like the slight non-correlation with the total stock market and possible diversification of interest-rate risk/reward and inflation risk/reward. I doubt it will make a huge difference in the grand scheme of things over 20 years, but I sleep well.
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Re: Why Not REIT's?

Post by indexonlyplease » Wed Jul 19, 2017 6:58 pm

harvestbook wrote:I have 5 percent of my stock portfolio in US REITS and 5 percent in global REITS as suggested by Paul Merriman. I like the slight non-correlation with the total stock market and possible diversification of interest-rate risk/reward and inflation risk/reward. I doubt it will make a huge difference in the grand scheme of things over 20 years, but I sleep well.
Just wondering if you also follow Merriman's recommeded small value tilting??

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