Investor appetite for REITs has declined with the COVID-19 pandemic and unlike the broader stock market, the asset class has yet to approach pre-COVID levels. While various sectors of the real estate industry face divergent outlooks, it is worth remembering the evolution of REITs and the long-term benefits of having them in a diversified portfolio. Among US REITs, certain sectors/sub-sectors look poised to benefit from a recovery. From a portfolio perspective, real estate offers meaningful diversification and income generation benefits with US REITs tending to play a “hybrid” role between equities and bonds.
US REITs are also required to distribute much of their taxable income as dividends, which is an attractive option for investors looking for periodic incomes. Furthermore, due to the substantial current sell-off, there may be areas of sectoral opportunities among REITs. For instance, many US REITs are now trading below their net asset value and certain undervalued properties have upside potential not least in terms of merger and acquisition activities post the pandemic crisis (Figure 3).
With the current low interest rate environment projected to continue into 2022, US REITs may outperform investment grade bonds as well, which should further improve their potential in terms of portfolio diversification. It should be noted that US REITs do not necessarily sell-off when interest rates rise as the correlation to the US 10-year Treasury yield going back to 1988 is 0.10.
REITs that are more sensitive to growth tend to favor modestly rising rates, reflecting prospects of a robust economy, while income-dependent REITs may thrive in lower-rate environments. Also, in a lower-interest regime, the divided streams from REITs have higher value.
The incorporation of US REITs in a total portfolio provides investors with core exposure to a wide range of commercial and industrial real estate properties. This hybrid asset’s potential diversification benefits, income yields and growth prospects may shine brighter as capital markets exit the lows reached in March 2020 and the economy continues to recover from the global pandemic.
Institutional investors use US REITs to gain exposure to the broad commercial and industrial property marketplace. Most US REITs own and operate income-producing real estate properties and structures and are characterized as hybrid assets on account of their equity and bond like features.
The basic legal structure of US REITs could provide stable current income to investors as they are required to distribute at least 90% of their taxable net income to shareholders. In addition, US REITs participate in long-term growth internally through occupancy and rent increases, tenant upgrades and redevelopment of existing properties and externally through accretive acquisitions, ground-up development and joint-ventures or fund management investments.
They are considered as highly liquid and transparent investment vehicles and are actively managed by experienced and professional management teams. REITs are diverse with exposures spanning across multiple sub-sectors, ranging from traditional office, industrial, healthcare and residential sectors to retail, hotels and specialized segments such as self-storage, data centers, and cell phone towers.
The author would like to acknowledge the contributions made by Katherine Winson to the article.
1Focused REITs are not part of Figure 1 as the figure is based on the Dow Jones U.S Select REIT Index. The Specialized sector in Figure 1 only encompasses public storage and data warehouses. Some indices choose to include cell towers in the Specialized sector and others do not, seeing them as belonging to the Communications sector and not as part of REITs.
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