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Amanda

The Beauty of REITs Part I

Updated: Nov 22, 2023

At 8:30 a.m. on November 14, 2023, I opened my laptop and read news as usual. This time, however, I finally came across some positive news. REITs notably outperformed the entire S&P 500 on Tuesday, surging by 5.3%. According to the Census Bureau’s consumer price index, inflation increased by 3.2% last month, a slower rate than the 3.7% observed in September. Investors eagerly poured in money after learning that inflation had slowed in October. “The interest rate rises should be over, and the Fed will have to consider cutting interest rates seriously,” National Association of Realtors Chief Economist Lawrence Yun said in a statement Tuesday. “In the meantime, the bond market is reacting as if the Fed will be cutting interest rates next year. Mortgage rates look to head towards 7% in a few months and into the 6% range by the spring of 2024.”


As someone who works in commercial real estate industry, I felt thrilled when I came across the good news. Then, it occurred to me that I must write something about REITs on my blog because, despite their significance in the real estate industry, a lot of people don't know much about this asset class, let alone take a closer look at it. So, in this piece, I will give a brief introduction to REITs and compare the REITs sector with the S&P 500 to show you the charm of REITs. In my next post, I will compare this sector with the private real estate sector and the bonds market to take a closer look at this asset.


What is a REIT?

  • A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate, which may include office, multifamily, data centres, healthcare facilities, hotels, infrastructure, and more.

  • To qualify as a REIT, a company must comply with certain provisions. Such as, investing at least 75% of total assets in real estate, deriving at least 75% of gross income from rents, interest on mortgages that finance real property, or real estate sales, and paying a minimum of 90% of taxable income in the form of shareholder dividends each year.

  • Most REITs are publicly traded like stocks, which makes them highly liquid (unlike physical real estate investments).

  • In generally, there are three types of REITs: Equity REITs - own and operates income-producing real estate; Mortgage REITs – don’t own real estate but lend money to real estate owners and operators either directly through mortgages and loans, or indirectly through the acquisition of mortgage-backed securities; Hybrid REITs - own properties and holds mortgages.



REITs vs Stocks

The reason for comparing REITs with stocks is that they are very similar and it would be interesting to see how their historical performances differ. Both assets are bought and sold in the form of shares on major exchanges, and acquiring either of them means owning a small portion of the company's ownership. Since, among all REITs, Equity REITs are the most similar to stocks, and the S&P 500 is perceived as the most representative index of the stock market, in the following sections, I will compare the returns and volatility of two indices that represent equity REITs and the stock market, respectively: the FTSE Nareit All Equity REITs and the S&P 500.


Returns


We can observe from the graph above that REITs and the S&P 500 have been moving almost in sync. However, it is evident that REITs have performed better in the long term. The returns of REITs tend to reach a higher ceiling, while S&P 500 is more likely to experience a lower floor. Moreover, the average return for Real Estate Investment Trusts (REITs) from 1972 to 2022 is 12.35%, which is 3.35% higher than the return of the S&P 500.


Volatility

In finance, beta (β) is a measure of the volatility—or systematic risk—of a security or portfolio compared to the market as a whole (usually the S&P 500). Therefore, the beta of the S&P 500 is standardized at 1, providing a baseline for comparison. To compare their volatility, we need to figure out the beta of REITs.


I have selected the top three constituent companies of the FTSE FTSE Nareit All Equity REITs from each of top five subsectors rated by their capitalization in 2023. These subsectors include residential, retail, infrastructure, industrial, and data centres. I then calculated the weighted average beta values for each sector and the whole equity REITs industry.


From the table below, we can observe that the total weighted average beta is 0.91, which is smaller than 1, implying that all equity REITs are less volatile than stocks. The retail sector stands out as the only industry more volatile than the S&P 500, with a weighted average beta value of 1.32. Additionally, despite the data centre being the most concentrated subsector with only two constituent companies, it has the lowest beta of 0.6.



Now, we can see that REITs are highly investment-worthy assets given their superior performance returns and lower volatility compared to the stock market. This is primarily due to the resilient cash flows that REITs offer. The income of REIT companies is derived mainly from income-generating properties, and these properties, in turn, generate stable rents. Additionally, most sectors in real estate, such as industrial, infrastructure, office, and data centres, have long-term leases, ensuring the stability of their incomes. Furthermore, as REITs are mandated by law to distribute a minimum of 90% of their taxable income in the form of shareholder dividends each year, investors in REITs can enjoy higher dividends than stocks and have the option to reinvest these dividends for greater returns.


I firmly believe that REITs are unquestionably excellent investments that deserve our attention. They combine the advantages of the private real estate market and the stock market, offering easy tradability, high liquidity, and the potential for stable income. In my upcoming post, I will compare REITs with the private real estate sector and the bond market to illustrate their differences and further unveil the attractiveness of REITs.


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