TOTAL STOCK MARKET index funds have 3% or 4% of their money in real estate investment trusts, or REITs. That means many investors—including many HumbleDollar readers—already have some exposure to REITs. But is it enough? For many, I think not.
I’m talking here about publicly traded U.S. equity REITs, not mortgage REITs or non-publicly traded REITs. Yes, the right allocation to real estate can be complicated by whether you own your home or have other real estate holdings. Still, I think it’s worth overweighting REITs—for seven reasons.
1. Returns have been excellent. REITs were created by Congress in 1960. We have reliable index data going back roughly 50 years. Morningstar recently calculated that REITs outperformed the S&P 500 by more than 1% a year between 1972 and 2019.
2. Real estate may be less risky than stocks. Many commentators have argued that REITs are volatile and therefore less attractive. For instance, Jeremy Siegel noted in Stocks for the Long Run that REITs lost 75% during the 2007-09 financial crisis. REITs have also been volatile during the COVID-19 crisis, with weekly REIT returns on both the upside and downside exceeding stocks for seven straight weeks.
But risk can be measured by various metrics and, while some indicate REITs are riskier than stocks, others imply the opposite. For instance, Craig Israelsen found that REITs had both higher returns than stocks and were arguably less risky, because they had a higher percentage of years with positive returns.
3. Real estate accounts for a large percentage of global wealth. It’s tricky to estimate the total value of worldwide assets. Roger Ibbotson and Laurence Siegel made the first comprehensive calculations in 1983 and estimated that real estate accounted for 52% of “the world market wealth portfolio.”
Gregory Gadzinski, Markus Schuller and Andrea Vacchino provided a more recent estimate in their 2018 paper. As of 2015, they concluded that real estate accounted for 20%—and forestry and agricultural land for an additional 2%—of the global capital stock. “A global market portfolio aiming at including the major economic forces would need to take into account this weight accordingly, instead of only accounting for assets under management held by REITs,” they wrote.
4. Homes—a large component of the real estate sector—have had similar returns to stocks, but with less volatility. Historically, homes only appreciate by a little more than inflation. But that’s not the right comparison to other investments. The authors of The Rate of Return on Everything, 1870–2015 added rental income, concluding that “residential real estate, not equity, has been the best long-run investment over the course of modern history.”
5. High net worth investors target high allocations to real estate. TIGER 21 is a group of individuals with at least $10 million to invest. Real estate was consistently the largest component of their asset allocation during 2016-19. Indeed, wealthy investors had 29% allocated to real estate at the end of 2019’s third quarter.
6. Institutional investors have had much stronger returns with public REITs than other real estate investments. CEM Benchmarking’s 2019 study reviewed asset class returns of public and private sector pensions, and found that their REIT returns over the last 20 years significantly outperformed both private funds and internally managed real estate.
7. This year’s bear market has made REITs even more attractive. REITs give investors the opportunity to buy one of the best long-term investments in a liquid, efficient form. Want to diversify your portfolio better—and perhaps set it up for higher long-run returns? Consider buying an index mutual fund or exchange-traded fund that focuses on REITs.
Gary Karz is a Chartered Financial Analyst, publisher of InvestorHome.com and author of The Peaceful Investor. His previous article was Make Less Keep More. He enjoys skiing, hiking, biking and snorkeling. A longer version of this article was previously published on InvestorHome.com. Follow Gary on Twitter @GKarz or email him at firstname.lastname@example.org.