After experiencing large portfolio drawdowns this year due to weakness across global equity markets, many investors are currently looking for assets that can provide protection against stock market turbulence. And with inflation at multi-decade highs, and interest rates rising rapidly, investors are also on the lookout for assets that can offer some protection from the negative impact of these trends.
Among the types of assets that appear to satisfy these requirements are real estate investment trusts (REITs). Often overlooked by investors, these are publicly traded investment companies that own or finance real estate portfolios. REITs offer investors many benefits including high dividends, inflation protection, a relatively low correlation to the broader stock market, and low transaction costs. Given these attributes, they could be a good asset to consider for diversification in the current “risk-off” environment.
Learn more about eToro’s RealEstateTrusts Smart Portfolio here.
How do REITs work?
Real estate investment trusts are essentially investment companies that own, operate, or finance income-generating real estate assets. They are similar to regular investment funds in that they pool together capital from many investors so that the investment managers of the entity can make larger investments.
REITs can be a great way for smaller investors to get exposure to the real estate market. They are listed on the stock market, just like stocks, which makes them highly liquid (unlike physical real estate which can take months to buy or sell). Meanwhile, transaction costs are very low. With these real estate investments, you don’t need to worry about paying thousands in stamp duty and real estate broker costs like you would with physical real estate.
REITs tend to specialise in one area of the real estate market. Some of the main areas of real estate in which they invest include:
- Apartment buildings
- Office buildings
- Shopping malls
- Hotels
- Healthcare facilities
- Online shopping warehouses
- Self-storage facilities
- Data centres
To qualify as a REIT, companies usually have to meet certain criteria. In the US, for example, a company must have the bulk of its assets and income connected to real estate investment, and distribute at least 90% of its taxable income to shareholders annually in the form of dividends. Similarly, in the UK, a REIT must distribute 90% of the profits from its property rental business to its shareholders.
Why REITs could be a good investment in 2022
In the current environment, real estate investment trusts could potentially play a valuable role in investor portfolios.
One major advantage of REITs is that they don’t move in perfect sync with the stock market. And they often hold up better than the broader market during periods of stock market turbulence due to the fact that their income streams are quite resilient. However, REITs still produce stock market-like returns over the long run. Believe it or not, REITs, as a whole, have often outperformed stocks over the long term. Between 1972 and 2019, for example, the FTSE NAREIT Index generated a return of 13.3% per year. That was higher than the return from the S&P 500 index, which delivered a return of 12.1% per year.
Another key benefit of real estate investment trusts is that they pay regular dividends. And yields can be attractive. Right now, many REITs have yields of 4% or more. That means it is possible for individual investors to earn income from the real estate market, without having to buy or manage properties themselves. In the current environment, in which capital gains are hard to come by, regular dividends are worth their weight in gold.
In addition, REITs can offer protection against inflation. When inflation is high, real estate landlords can raise their rents to cover rising costs (long-term leases are often tied to inflation). This supports dividend growth. Meanwhile, real estate values often increase when prices are rising. This is because higher prices for labour, materials, and land make construction less economically viable, reducing supply.
It’s worth noting that in the 1970s, when inflation was sky-high, real estate investment trusts performed very well. In fact, they were actually the second-best performing asset after energy stocks.
Past performance is not an indication of future results.
The caveat here is that although REITs did perform well over the decade, they didn’t go up in a straight line. For instance, asset prices experienced some weakness in the OPEC-related recession of 1972 to 1974.
As for rising rates, REITs should be protected to a degree due to the fact that many have fixed-rate debt with longer maturities. So, increases in short-term interest rates shouldn’t have a big impact on their cost of capital.
Putting this all together, REIT stocks look very appealing right now. Not only can they potentially provide both portfolio diversification and dividend income, they can also potentially protect against inflation and rising interest rates.
How to invest in REITs
To make it easy for investors to get exposure to real estate investment trusts, eToro has created the RealEstateTrusts Smart Portfolio. This is a fully allocated investment portfolio that is focused purely on REIT stocks.
Through this Smart Portfolio, investors can gain exposure to a range of leading REITs, including those that own and manage residential, office, warehouse, healthcare, and storage real estate.
You can find out more about eToro’s RealEstateTrusts Smart Portfolio here.
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