How Can REITs Fit into Your Financial Plan?
REITs, or Real Estate Investment Trusts, allow individuals to invest in income-generating real estate without having to physically buy, manage, or finance any properties themselves. Some examples of income-generating real estate that you can invest in through REITs are apartments, office spaces, and shopping malls.
There are certain advantages to investing in REITs over physical property: compared to physical property, REITs are highly liquid because they’re traded on the stock exchange.
REITs also allow investors to hold partial ownership across several properties instead of having to buy whole properties, reducing the risk of concentrating too much of their wealth in any single property.
These features make REITs a convenient way to invest in real estate. But, how do they compare against other asset classes, such as stocks and bonds? Below, we cover how REITs can fit into your financial plan:
REITs provide diversification in a portfolio
Adding REITs to a portfolio that also contains stocks and bonds allows investors to diversify their investments: it introduces an additional asset class on top of stock and bonds and exposes a portfolio to different types of real estate.
Ultimately, this diversification across asset classes and real estate types helps investors balance risk in their portfolio.
As an asset class, REITs are generally less volatile than stocks: unlike stocks that expose investors to company returns, REIT returns reflect real estate returns, which generally fluctuate less than company returns.
But, REITs are more volatile than bonds: unlike bond yields, which are fixed, REIT dividends can fluctuate based on economic conditions and the decisions of the REIT’s managing company. For example, a REIT manager might increase a REIT's value by improving the occupancy and rental rates of existing properties or by acquiring and selling properties.
REITs also provide diversification across real estate in different sectors and geographies, protecting investors from events that could affect a specific type of real estate. For example, over the course of the last year, some REITs performed much better than others due to the pandemic’s effects: an increase in remote working arrangements caused data centre REITs to rise in value, while office REITs declined in value.
One way to achieve a high level of diversification within real estate is with a REIT ETF, or Exchange Traded Fund. For example, the Vanguard Real Estate ETF (VNQ US) gives investors immediate exposure to 178 different US REITs.
REITs can provide income
While company stocks can provide capital appreciation over time, REITs are highly attractive for investors who want to earn passive income from their assets.
REITs often pay relatively high dividend yields compared to corporate and government bond dividends. For example, in the US, REITs must distribute at least 90% of their taxable income to their shareholders as dividends to retain their tax-free status.
An investor in REITs would receive regular dividends, just like how they would receive rent from commercial properties that they own. They can then either cash out their dividends or reinvest them into more REITs.
REITs can protect your portfolio against inflation
REITs tend to perform well during strong growth and inflation periods, such as now, as economies start to re-open in anticipation of a post-pandemic world. With inflation, the purchasing power of the dollar reduces, but certain asset classes such as REITs are likely to appreciate.
Think of inflation's impact on REITs this way: When there's inflation, costs rise. This rise in costs directly impacts real estate rents and values, pushing up REIT dividend growth. So, being invested in REITs during inflationary and growth periods provides a reliable stream of income and buffers your portfolio against inflation’s effects.
Find out more about inflation’s effects and inflation-hedges.
What to consider when deciding whether to invest in REITs
When deciding whether to invest in REITs, consider how REITs can help you achieve your short-term needs and long-term financial goals. In the short term, REITs can supplement income. And in the medium and long term, they provide diversification, balance risk, and minimise volatility in your portfolio in times of inflation and growth.
At StashAway, our algorithm recently detected clear economic growth signals. That’s why our recent re-optimisation includes a higher allocation to US REITs and other inflation-protection assets in our clients’ portfolios. Ultimately, this allocation helps our portfolios remain resilient in the new economic environment and sets them up for long-term success.