REIT Research

Investing in real estate is a popular wealth-building strategy. As it would take the average first-time buyer nine years to save a deposit, buying even one property may seem like a pipe dream. Real estate investment trusts (REITs) are often billed as a way for the everyday investor to stick a finger in the property pie, to become a ‘lazy landlord‘. Should REITs form part of a diversified investment portfolio?

Returns from REITs

It’s important to avoid conflating the returns of REITs with those of real estate. The latter are difficult to divine and can be manipulated to support one’s argument (1). Although in the long term the returns may be similar, I’ve tried to keep things purely ‘REIT’ for my own research.

Similarly, the time period examined is all-important, and it can also be subtly twisted to fit a narrative. For example, anyone looking at REITs’ performance c. 2008 wouldn’t touch them with a barge pole. I’ve mitigated this by quoting the relevant time period where possible.

UK

UK REITs recently celebrated a fifteenth birthday following their advent in January 2007. How has this fairly nascent market fared in that time?

UK REITs have provided annualised returns of between 3.9% and 5.1% since 2016, depending on which source you use (2,3). It was a bumpy ride too. The FTSE EPRA Nareit UK REIT index has a 5yr volatility of nearly 17%, provided negative returns in four of the past ten years and had a maximum drawdown of -38% during that time.

Over a 2009-2019 timeframe the outlook was a little rosier, with 10yr returns of 9.7%. This was greater than both UK equities (9.1%) and gilts (8.5%). REITs paid out dividends at inflation-beating rates too.

The UK REIT market remains a relative fledgling space, one that “needs to grow” (4). If you do buy UK REITs, be careful about which day of the week you buy them on (5)!

Perhaps you don’t want to invest exclusively in UK REITs though – what about returns from the country with the longest running REIT market?

USA

US REITs have been around since the 1960’s. The Nareit Equity REIT Index (an index of US REITs) had an annualised return of 7.1% for the fifteen years 2006 – 2020. Returns lagged behind those of large-cap & small-cap stocks, and high yield bonds, and with greater volatility to boot (7).

Since 2008 the returns (7% vs. 9%) and volatility (24% vs. <20%) of the Vanguard Real Estate ETF were worse than iShares’ large- and mid-cap US equity ETFs (8). Over a longer timeframe (2001-2020), however, REITs had a greater annualised return (9.7%) than all other asset classes (9). They still had the highest volatility though.

Period table demonstrating the annualised performance of various (US) asset classes between 2006 and 2020. Source: JP Morgan (7)

Expanding the timeframe even further (1994 – 2019), the returns from US REITs remain about 9-10% (10), similar to portfolios of entirely US equities or a 50/50 blend of equities/REITs. The catch is in the risk however, with more volatility from a 100% REIT portfolio (19% vs. 15%), and a maximum drawdown of -70%, which was at least 10% greater than the other portfolios.

In the long run, returns between US REITs and the S&P500 are fairly similar. Since 1972 annualised returns of the FTSE Nareit All REIT Index have been 11 – 13% (11, 12). Over the same time period the S&P500 returned 12.2%. In general, US REITs appear to match or outperform US equities over longer periods, typically those of more than 15 years (11, 13 – 15).

Time periodFund/IndexAnnualised ReturnsVolatilityS&P500 returns/volatility
2006 – 2020Nareit Equity REIT Index7.1%23.1%9.9% / 16.7%
2008 – 2021Vanguard Real Estate ETF7%24%9.8% / 17.8%
1994 – 2019US REITs9.3%19.3%9.3% / 18.0%
1972 – 2019 FTSE Nareit All Equity REITs13.3%12.2% / 17.4%
1972 – 2020 FTSE Nareit All REIT11.4%10.8% / 17.2%
The returns from various US REIT funds/indices over different time periods. Overall the trend is that returns are better over longer timeframes. Over shorter lengths of time the returns from US REITs appeared to lag behind US equities and the REITs had greater volatility. In the long run returns appear to match, if not outstrip, those from equities.

What does the future hold? Blackrock predict 30yr annualised returns from US core real estate of 6.4% (range 2.5% – 10.4%) and 12.3% volatility (16).

Global

If you’re following a globally diversified, passive investing approach then you may prefer to sample REITs from all corners of the Earth rather than those from any one region.

Between 2005 and 2014, global REITs had an annualised average return of 6.7% (17). The FTSE EPRA Nareit Developed REIT index, which comprises a blend of North American, European and Asian real estate markets, has had a reasonably up-and-down time over the past 20yrs (18).

REITs are increasingly prevalent as a real-estate investment tool on the global stage. Source: Nareit.

The iShares Global REIT ETF has an average annual return of 4.9% over five years, or 6% over seven years, similar to the FTSE EPRA Nareit Global REITs Index (3) Over ten years the price returns are similar from both the S&P Global REIT Index (4.7%) and MSCI World REIT Index (5.5%). The latter’s volatility was 1% higher than the corresponding global equity fund in that time. Consequently the equity fund had a Sharpe (risk-return) ratio that was nearly twice as high. In general, REIT returns carry more volatility risk than their corresponding equity indices across multiple developed markets (20).

Monevator’s ‘slow and steady passive portfolio’ provides a useful case study of asset class performance (19). Their global property allocation has gained 38% since 2011, which lags significantly behind other sectors such as emerging market equities (59%), global small cap equities (79%) and developed world ex-UK equities (89%). Indeed only their bond and UK equity holdings have performed worse. Their real estate fund, however, doesn’t contain exclusively REITs.

My take home is that, in the short term, the returns on REITs have historically fallen short of those on equities, with the unwelcome addition of greater volatility. Over longer time periods the returns may approximate to (or even surpass) those of equities, though the volatility risk remains.

Spreading risk

I wondered whether REITs perhaps offer a diversification benefit for equities, which might merit their inclusion in a portfolio even if their risk-adjusted returns did not.

Unlike returns, the timespan doesn’t appear to greatly affect REITs’ correlation with equities. During a 40 year period (1970-2010), REITs were highly correlated with both equities and bonds (21). Of interest, commodities offered the greatest diversification hedge in that time.

Multiple sources demonstrate high (typically ≥0.7) correlation between US REITs and US equities (7, 8, 13, 22 – 25). Other findings include:
• Moderate-to-high correlation with global equities
• Variable correlations with bonds, ranging from moderately negative to moderately positive
• Low-to-moderate correlation with commodities
• Low/no correlation with cash

This relationship isn’t confined to US REITs, with a similar picture across European, Asian and Global REIT markets too (26 – 28).

Ben Carlson hit the nail on the end when he concluded that “investors say they want non-correlated assets but what they really want is non-correlated assets that don’t get crushed when stocks fall” (29). The evidence suggests that REITs aren’t going to offer that sort of benefit, correlating highly with equities during market downturns (30). Indeed Larry Swedroe has called REITs an “equity security with only marginal diversification benefits” (31).

The performance of the Wilshire US REIT Total Market Index during US recessions. Certainly for the GFC (2008) and Covid Crash (2020) there were big dips in US REIT values during market downturns. This belays the idea that REITs could offer a diversification benefit for equities. Source: Fred Economic Data

There’s a smorgasbord of different types of REIT, but correlations among them also appears to be high (28, 32). Despite this there’s evidence to suggest that a global REIT portfolio performs better than one that’s country- or region-specific (33, 34).

Inflation

Real estate is often lauded as an inflation hedge – could REITs provide a similar benefit? One analysis found conflicting results among six studies that assessed the ability of REITs to act as an inflation hedge (35). Dipping into said studies, the theme appeared to be that REITs are a better inflation hedge over the long-term, as are global REITs rather than US-only ones.

Smoke and mirrors

There’s some doubt as to whether REITs even constitute an independent asset class. According to one study (36), the returns of REITs could be achieved by using a portfolio of small cap value stocks (2/3rds) and long-term corporate bonds (1/3rd) – this blend even had better risk-return characteristics than REITs. It does indeed appear that REITs behave like equities in the short-term, only acting as a real estate asset over longer time periods (35, 37 – 38).

I would hazard that the average retail investor is probably uninterested by this. Sure they could gain the same returns from REITs, without the idiosyncratic real estate market risk, by using a blend of small cap equities and corporate bonds. But they’re probably more interested in feeling like they have some real estate exposure. So that if real estate explodes in value then they’ve already put their finger in the pie.

Space for REITs in your portfolio?

Taken in isolation, REITs appear to offer equity-ish returns but with higher volatility. They function as neither a diversifier for equities nor an inflation-hedging asset. Could they still be some use as part of a multi-asset portfolio?

One paper, from 2006, suggests that the difference in returns between REITs and equities should influence portfolio allocation, rather than their price correlation (39). However we know that the time period over which REITs’ performance is assessed can lead to higher or lower return figures, and consequently a different optimal allocation in a portfolio (40).

60/40

Adding 10% REITs to a 60/40 portfolio [i.e. making a 52/38/10 portfolio of equities, bonds and REITs] marginally improved annualised returns (+0.1%) and reduced volatility (-0.1%). Looking at ten year rolling periods from the 1990-2014 timeframe, the addition of REITs improved returns 80% of the time and reduced volatility 65% of the time (41).

A different analysis found that before 2006 adding 10% or 20% to a 60/40 portfolio did not significantly impact upon returns. After 2006, doing so only increased the value at risk (42).

The effect of adding 5 – 15% global REITs to all equity, 80/20 and 60/40 portfolios. Adding REITs improved risk-adjusted returns for the 100/0 and 80/20 portfolios, but increased both return and risk of a 60/40 portfolio. Overall the improved returns were rather modest (≲0.6%). The timeframe is 1990-2014, so doesn’t incorporate the most recent years. Source (43).

Other blends

One blogger publishes their REIT-containing USD growth portfolio. It consists of 27% REITs, as well as equities (27%), bonds (22%), gold (22%) and cash (1%). It boasts 16.1% annualised returns since 2005 (44). They’ve back-tested it against other portfolios:
• A 1/3rd each equity/bond/gold portfolio
• A 50/50 equity/bond portfolio
• An S&P 500 ETF

The 27% REIT portfolio had a CAGR of 10%, which was comparable to the other three (9.5%, 9.5% and 10.2% respectively). It did so with comparatively middling volatility of 9.9% (vs. 8.9%, 8.3% and 15%) and a lesser maximum drawdown of -15% (vs. -17%, -18% and -50%). This would appear to support the case for REITs as part of a multi-asset portfolio, although this is a USD-denominated portfolio that is unlikely to suit those wanting a global approach.

Conversely, a study found that REIT allocations of 10 – 30%, as part of an equity/REIT portfolio, did not improve risk-return or drawdowns compared to the 100% equity portfolio (27). Delving a bit deeper, REITs were the only strategy in their analysis that would have decreased risk-adjusted returns of an equity portfolio (2010 – 2019). Other strategies, e.g. dividend stocks, high-yield bonds or low-volatility portfolio, provided better risk-adjusted returns than REITs. In fact one paper found that no optimally risk-adjusted portfolio featured a real estate index (45).

In a series of copy-paste papers, Newell and Marzuki examined the portfolio diversification benefits of various country-specific REITs. They found that UK, German, French and Spanish REITs all demonstrate limited diversification benefits (46 – 48), although the same isn’t necessarily true of Irish or Belgian REITs (49, 50). This is supported by a similar finding across the European REIT market (51).

DIY

I had a play around with the portfolio-finder tool over at Portfolio Charts. I asked it to find the portfolios with the best historical risk-adjusted returns. Sadly the modelling is constrained by having equal asset class weighting and only up to ten different assets.

Nevertheless, US REITs featured in eight of the ten best risk-adjusted return portfolios. The best portfolio [US all-cap equities, ex-US intermediate bonds, gold and US REITs] had a conservative long-term return of 4.9% and an ‘ulcer index’ (a composite measure of drawdown depth, length, and frequency) of 5.4%.

Tinkering even further, I added 5, 10, 15% or 20% US REITs to a 100% global equity portfolio:

REIT allocation (%)0510152025
Average return (%)6.86.97.07.07.17.2
Volatility (%)181717171717
Loss Freq. (%)292929292927
Ulcer index (%)212019181817
Start date sensitivity (%)282827272626
SWR (40yr; %)3.33.43.43.53.63.7
The addition of REITs to a 100% equity portfolio provided only marginal improvements across a spectrum of performance markers.

It was a similar story when I back-tested various portfolios using Portfolio Visualizer. The addition of REITs provided some benefits, but nothing earth-shattering.

How much is enough?

You can find recommendations for just about any allocation to REITs in your portfolio. They are entirely absent from a number of classically described portfolios, which may be reassuring to the REIT-less investor.

Of the 19 ‘professional’ portfolios on Portfolio Charts, ten contain REITs. At the lower end of the spectrum is a 4% allocation in the global market portfolio, although the original paper features a portfolio of 3.3% real estate and not explicitly as REITs (52). Most of the portfolios contain 5 – 8% REITs. The highest allocation is 20% (Ivy League and Swensen portfolios), although Swensen later revised his suggested REIT allocation to 15% following the global financial crisis.

Among the personal finance bloggers who publicise having REITs in their portfolio, there’s a trend towards a slightly higher allocation – the median value is closer to 10%. Various sources (38, 53, 54) suggest optimal allocations of 15 – 25%, although of note none contain data from the past ten years, which makes their applicability debatable.

Index investing guru Jack Bogle supposedly said of REITs: “I could see an investor owning the Vanguard REIT fund, but I don’t think they should make it more than 10 percent of his or her portfolio. No one should get overexposed to any one sector, and I’d be especially cautious when that sector is hot.”

It may be that you don’t require a dedicated REIT in your portfolio if you’re already in possession of a global index fund. Many of the popular funds already contain a small wedge of real estate:
HSBC FTSE All-World Index Fund – 1.1%
iShares MSCI ACWI ETF – 2.7%
Vanguard FTSE All-Word ETF – 2.9%
Vanguard FTSE Global All Cap Index Fund – 3.7%

A different story

In my opinion, REITs shouldn’t be seen as the direct surrogate for property investing they are sometimes made out to be. Their relationship to real estate (and equity) returns is nuanced.

Globally the REIT market is still fairly juvenile, especially outside of the US. As more countries adopt the approach both the performance characteristics of REITs and their correlation with other asset classes may change.

I personally found little compelling evidence that REITs are a must-have in a portfolio. To be fair there wasn’t a great deal to suggest including them would be too perilous either. Overall I suspect there could be a strong behavioural element in the decision to invest in a REIT, especially for the investor otherwise devoid of (physical) real estate.

TTFN,

Mr. MedFI


References
1 – How To “Lie” With Personal Finance – Part 2 (Homeownership Edition). Early Retirement Now. 2019. Link
2 – Private real estate versus REITs – which performs best over the long term? T Fong. Schroders. 2020. Link
3 – FTSE EPRA Nareit UK Index Factsheet. FTSE Russell. 2021. Link
4 – How to solve a problem like liquidity: REITs and the UK property sector. FT Adviser. 2019. Link
5 – UK REIT sector needs to ‘grow a lot bigger,’ say top property executives. C McElroy. S&P Global Market Intelligence. 2021. Link
6 – UK REITs don’t like Mondays. A Jadevicius & S Lee. Journal of Property Investment & Finance. 2017. Link
7 – Guide to the Markets. JP Morgan Market Insights. 2021. Link
8 – Asset Class Correlations. Portfolio Visualizer. 2021. Link
9 – Asset Allocation Diversification – 20 Years of the Best and Worst. MFS. 2021. Link
10 – Alternative investments. Mindfully investing. Link
11 – REITs vs. Stocks: What Does the Data Say? M DiLallo. Millionacres. 2020. Link
12 – Annual Returns by Investment Sector: 1972 – 2020. Nareit. Link
13 – Why I’m Lukewarm on Real Estate. A Arnott. Morningstar. 2021. Link
14 – REIT Average & Historical Returns Vs. U.S. Stocks. N Funari. Nareit. 2020. Link
15 – REITWatch: A Monthly Statistical Report on the Real Estate Investment Trust Industry. Nareit. 2021. Link
16 – Capital market assumptions. Blackrock Investment Institute. 2021. Link
17 – What Do Global REITs Add to a Portfolio? G Fisher. Forbes. 2015. Link
18 – The Callan Periodic Table of Investment Returns: Year-End 2020. Callan. Link
19 – The Slow and Steady passive portfolio update: Q2 2021. The Accumulator. Monevator. 2021. Link
20 – Extreme returns and value at risk in international securitized real estate markets. K H Liow. Journal of Property Investment & Finance. 2008. Link
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22 – Asset Class Correlation Map. Guggenheim Investments. Link
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24 – Correlation Matrix for the 14 Asset Classes. Morningstar. Link
25 – Asset Class and Portfolio Risk and Return. AA Research Affiliates. Link
26 – REITs and Correlations with Other Asset Classes: A European Perspective. J Niskanen & H Falkenbach. Journal of Real Estate Portfolio Management. 2010, 16 (3). Link
27 – The Case Against REITs. N Rabener. Factor Research. 2019. Link
28 – Chartbook: SREITs & Property Trusts. SGX Research. 2021. Link
29 – Is Real Estate a Non-Correlated Asset Class? B Carlson. A Wealth of Common Sense. 2018. Link
30 – Extreme Risk Measures for International REIT Markets. J Zhou & RI Anderson. The Journal of Real Estate Finance and Economics. 2012, 45; 152 – 170. Link
31 – The Role of REITs in a Diversified Portfolio. L Swedroe. Advisor Perspectives. 2017. Link
32 – Investing In REITs – Are Real Estate Investment Trusts a Good Investment? Pensioncraft. 2020. Link
33 – Is there convergence between the BRICS and International REIT Markets? Akinsomi et al. 2018. Link
34 – REITs Portfolio Optimization: A Nonlinear Generalized Reduced Gradient Approach. RYM Li & A Chan. International Conference on Modeling, Simulation and Optimization. 2018. Link
35 – What are the inflation beating asset classes? Schroders Investment Perspectives. Link
36 – Are REITs a Distinct Asset Class? J Kizer & S Grover. 2017. Link
37 – The Rate of Return on Everything, 1870–2015. O Jordà et al. Federal Reserve Bank of San Francisco. 2017. Link
38 – The Case for REITs in the Mixed-Asset Portfolio in the Short and Long Run. S Lee & S Stevenson. 2002. Link
39 – The Stock-REIT Relationship and Optimal Asset Allocations. D Waggle & P Agrrawal. Journal of Real Estate Portfolio Management. 2006, 12 (3). Link
40 – Mean‐variance analysis with REITs in mixed asset portfolios: The return interval and the time period used for the estimation of inputs. D Waggle & G Moon. Managerial Finance. 2006. Link
41 – Why We Believe Your Portfolio Needs Global REITs. Gerstein Fisher. 2014. Link
42 – REITs in a Mixed-Asset Portfolio: An Investigation of Extreme Risks. S Stelk et al. The Journal of Alternative Investments. 2017, 20 (1) 81-91. Link
43 – Taking a Global Approach to Investing in Public Real Estate. Gerstein Fisher. 2014. Link
44 – USD Growth Portfolio. The Obvious Investor. Link
45 – Real Estate Betas and the Implications for Asset Allocation. P Mladina. Journal of Investing. 2018. Link
46 – The significance and performance of UK-REITs in a mixed-asset portfolio. G Newell & J Marzuki. Journal of European Real Estate Research. 2016, 9(2):171-182. Link
47 – The emergence and performance of German REITs. G Newell & J Marzuki. Journal of Property Investment & Finance. 2018. Link
48 – The emergence of Spanish REITs. G Newell & J Marzuki. Journal of Property Investment & Finance. 2018. Link
49 – The development and initial performance analysis of REITs in Ireland. G Newell & J Marzuki. Journal of Property Investment & Finance. 2019. Link
50 – The evolution of Belgium REITs. G Newell & J Marzuki. Journal of Property Investment & Finance. 2019. Link
51 – The Return Performance of Real Estate Investment Trusts (REITs) and Portfolio Diversification Benefits: Evidence From the European Market. P Alexis & P Alexakis. Recent Advances and Applications in Alternative Investments. 2020. Link
52 – Historical Returns of the Market Portfolio. R Doeswijk et al. Review of Asset Pricing Studies. 2019. Link
53 – Investing in Mixed-Asset Portfolios: The Ex-Post Performance. C Fugazza et al. Centre for Research on Pensions and Welfare Policies. Link
54 – Strategic Asset Allocation: Determining the Optimal Portfolio with Ten Asset Classes. N Bekkers et al. The Journal of Wealth Management. 2009, 12(3). Link


3 thoughts on “REIT Research

  1. Great post. Thanks for putting it together.

    I find it funny that in the UK, everyone is property mad but only when it comes to housing benefit farming.
    REITs are an obvious investment choice for those who want exposure to property without the hassle but it’s not too popular for some reason.
    Hence why half of the foreign investment in the UK is in buying up property.

    Liked by 1 person

    1. Thanks GFF. I think my research has led me to conclude that owning real estate and owning a REIT is not a like-for-like comparison. Most property owners will, presumably, stick to residential real estate rather than branching out into other areas such as commercial – REITs will facilitate the latter to a greater degree.

      Like

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