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REITs: An investment vehicle for diversifying your wealth

13 Minute Read

There are countless success stories of people who have used real estate investing to greatly increase their net worth. But should you consider adding income property to your overall investment portfolio?

Although real estate holdings can help an investor address goals around income and portfolio diversification, acquiring and managing properties can be daunting. But there are other ways to invest in real estate outside of direct property ownership.

An investment vehicle to consider and discuss with your financial advisor is called a real estate investment trust, or REIT. This investment option provides exposure to the real estate market without direct or active ownership and the related responsibilities.

What is a REIT?

A REIT is a special type of corporate entity that primarily owns or finances real estate with the requirement of paying out operating income to investors. Equity REITs are formed to purchase income-producing residential or commercial property whereas mortgage REITs provide financing to the sector. Individual REITs typically focus on specific property types, such as office buildings, retail, or multi-family housing.  Even cell phone towers and data centers can be structured as REITs.

A REIT is typically comprised of a basket of real estate equity or debt investments. As a REIT shareholder, investors can expect to receive non-qualified dividends from the income generated by these underlying investments in a passive way – in other words, shareholders do not take on the typical responsibilities of someone who directly owns real estate, such as buying, managing, and financing the property.

REITs can be either publicly listed or privately offered. Similar structures also exist outside of the U.S., which could provide global diversification opportunities. Investors looking for diversification across a basket of publicly traded REITs may consider professionally managed mutual funds or exchange-traded funds (ETFs) that focus on the asset class.

Why invest in REITs?

Passive Involvement. A real estate investment trust allows investors to obtain many of the benefits of real estate investing without requiring expertise and all the time-consuming duties associated with directly owning property. REIT investors do not directly control the portfolio of properties, which could prove beneficial to investors looking for the investment opportunity without a large time commitment.

Income. REITs are generally expected to generate regular cash flow, which can be important to many investors, particularly retirees. Most importantly, REITs receive unique tax treatment compared to traditional corporate structures. Unlike traditional companies, REITs are not subject to corporate income tax. In return for this favorable tax treatment, REITs are required to pay out 90% of taxable income to shareholders, most commonly as non-qualified dividends. As a result, REIT dividend yields are often much higher than those paid by the average stock. In addition to income, the total return of equity REITs will include the capital appreciation of the underlying properties.

Diversification. Most financial advisors recommend that investors develop a diversified portfolio, of not only stocks and bonds, but also alternative investments. Direct real estate, as an alternative asset class, has exhibited low correlation to interest rates and the stock market. Equity REITs, on the other hand, provide lower correlation to interest rates, and as such can provide additional diversification particularly against bonds to help round out a portfolio. Further, investors can diversify their existing real estate holdings by looking at different property types or geographies. Investors, however, should consider the higher correlation of equity REIT securities to broader equity markets to ensure they are comfortable with the level of volatility of the asset class.

U.S. Investments - REITs, real estate, and equities - 12-quarter rolling correlations, total returns

Liquidity. Publicly traded REITs are fairly liquid and largely can be bought and sold with the same convenience as any other publicly traded stock. This contrasts with direct ownership of real estate where the owner is unable to generate meaningful liquidity from the asset without going through a complicated and sometimes lengthy sale or refinancing process. However, the liquidity advantage comes with a tradeoff in the form of higher volatility relative to the value of the underlying properties. REITs may trade at a discount or premium to the appraised fair market value of the underlying assets.

Competitive historical returns. While past performance is not necessarily indicative of future returns, investors may take comfort in the fact that equity REITs have historically delivered total returns in line with the broader stock market.

In 2021, equity REITs had their best year in total returns since 1995, at 41.2%, as measured by the Dow Jones Equity REIT Index. During the same period, equities fared well — the S&P 500 Index produced 28.7% returns — but fell short of REIT performance. [Source: Bloomberg]

In today’s low-interest rate environment, REIT dividend yields may be considered an attractive alternative to cash in a bank deposit account or to bonds. There are many equity REIT ETF options that provide investors an additional 300+ basis points versus a bank deposit account, but investors should understand the additional volatility that comes with that income potential.

Potential drawbacks

There are caveats to REIT investing as well.

Potential tax liability. Unlike direct real estate investments that can defer capital gains tax into perpetuity through a process known as a 1031 exchange, investors are unable to defer taxation on capital gains when they sell REIT shares.

Not always the best protection against inflation. REITs have a reputation for being defensive against inflation, and as a result have been drawing a lot of public interest. But that reputation is only accurate in certain environments. REIT performance can actually falter when the growth in inflation outpaces the rise in interest rates, particularly if economic growth is weak.

REIT investment returns compared to S&P 500 returns during different inflation periods

A lack of control over the underlying assets. Unlike investors who directly own real estate, investors in REITs do not control what properties are being bought or sold.

Higher expenses. Depending on the REIT structure and underlying assets, the professional management of the assets are likely to come with higher fees. It’s important for investors to fully understand the underlying costs of any investment, be that private or public investments.

Property-specific risks. Certain property types may be more sensitive to economic conditions than others. Hotel REITs, for example, are more likely to perform poorly in an economic downturn. Investors should also consider disruptive economic changes, such as the post-COVID pandemic impacts to office occupancy and therefore a challenging backdrop for office REITs.

How your financial advisor can help you with REITs

The key to investing in REITs, as with any investment, is to ensure the allocation of funds supports your overall portfolio goals. A financial advisor can help you review your existing investments, your risk profile and future liquidity needs to determine if real estate — either in the active capacity or in a passive real estate investment option like REITs — would meet those needs and enhance your portfolio.

Additionally, some advisors can help you select specific REIT investments. Like any individual stock or bond investment, it is important to understand individual REITs in the context of their overall sector, as well as their idiosyncratic features before making an investment decision. Again, it is important to evaluate any investment within the context of your existing overall portfolio and financial goals.


To learn more about active or passive real estate investing through REITs or other vehicles, contact The Private Bank at Union Bank.


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This is a publication of The Private Bank at MUFG Union Bank, N.A. (the Bank). This publication is for general information only and is not intended to provide specific advice to any individual. Some information provided herein was obtained from third-party sources deemed to be reliable. The Bank makes no representations or warranties with respect to the timeliness, accuracy, or completeness of this publication and bears no liability for any loss arising from its use.

Wills, trusts, foundations, and wealth-planning strategies have legal, tax, accounting, and other implications. Clients should consult a legal or tax advisor.

Investment management services offered by MUFG Union Bank, N.A. in conjunction with its subsidiary, HighMark Capital Management, an SEC-registered investment adviser. Investments employing managed strategies: • Are NOT deposits or other obligations of, or guaranteed by, the Bank or any Bank affiliate • Are NOT insured by the FDIC or by any other federal government agency • Are subject to investment risks, including possible loss of the principal amount invested.

Alternative asset classes may help improve a portfolio’s risk/return profile. They are also subject to a higher degree of risk and can involve significant loss.