PITTSBURGH — The average investor isn’t going to buy into a shopping mall or an apartment building. But investing in real estate can be a useful way to diversify a portfolio.
That’s why, especially when interest rates are low, fixed-income investors looking for alternative investments to maintain sufficient yield are giving more attention to real estate investment trusts.
Real estate investment trusts, also called REITs, allow investors to passively invest in real estate without directly owning property.
REITs are a hybrid because they trade like stocks, but they are different from stocks of regular companies because they invest in income-producing real estate, such as apartment buildings, hotels, office buildings, hospitals and shopping centers.
There are currently 14 such trusts featured in the Standard & Poor’s 500 stock market index.
Although they occupy a relatively small niche in the financial sector, the market share is growing. REIT Magazine reported in April that mergers and acquisitions of such trusts are on the rise. There were $17.4 billion in merger and acquisitions deals in 2014; $43.8 billion in 2015; and $50.6 billion in 2016.
“Yield-seeking investors who choose to add REIT funds to their portfolio must remain cautious,” said Thomas Walsh, a portfolio manager with Palisades Hudson Financial Group in Atlanta. “While REIT funds offer good yield, like all other equities, they are volatile.
“But because REITs don’t typically move with the stock market, it’s one way to increase yield without increasing risk. It’s a way to diversify,” he said.
He recommends investors limit such investments to 7.5 percent to 10 percent of their equity allocation.
One of the big advantages of investing in real estate investment trusts is they must pay out at least 90 percent of income to investors.
Howard Davis, president of the Davis, Davis & Associates accounting firm in Pittsburgh, said the distributions are taxable. That is not a problem for investors who have such holdings in their retirement plans because that income is deferred until the investor begins taking distributions at retirement age.
“A lot of times, a REIT investment is better off in a retirement plan,” Davis said. “But if you are paying taxes on REIT income, you have to consider that the value of the REIT itself fluctuates. If the REIT is not doing well, you could be paying taxes on an investment where the principle might be down.”
Benjamin Greenfeld, chief investments officer for Waldron Private Wealth, said his Pittsburgh-area firm’s exposure to such trusts increases or decreases as market conditions and valuations change. He doesn’t believe it’s a good idea to invest in the trusts in order to chase higher yields.
“We do think REITs have a long-term growth perspective on top of the income payouts,” Greenfeld said. “If interest rates are rising for the right reasons — such as a strengthening economy, declining unemployment or payroll increases — then REITs can benefit.”
“While in the short run there could be volatility from rising rates, if these other characteristics exist, then REITs can pass on rent increases, which helps valuations and cash flow.”
According to the Washington, D.C.-based website, REIT.com, which analyzes the macro- and micro-economic fundamentals impacting the REIT and commercial real estate industry, operating fundamentals are strong across nearly all property types and geographic markets.
Apartment markets continue to enjoy strong renter demand, especially in coastal markets. Office buildings owned by real estate investment trusts are finding steady tenant demand.
Retail, however, reported weakness in store traffic including bankruptcies in light of the broader challenge of e-commerce, according to REIT.com.
Advisers at Signature Financial Planning in Pittsburgh use all types of REITs in their client portfolios, which include publicly traded ones as well as non-traded versions. The non-traded ones are securities not listed on any exchange, but sold through brokers and financial advisers.
“REITs are the best and simplest way for average investors to gain access to meaningful real estate investments,” said Aaron Leaman, chief financial officer at Signature Financial Planning.
But investors should keep in mind that the trusts are riskier than bonds, and when it comes to non-traded REITs, they can be illiquid and carry expensive management fees. The trusts also are subject to the whims of the real estate market.
“If you invested in REITs in 2006 and 2007, you had a horrible time when the real estate market crashed,” Leaman said.
“But if you invested in 2009 and 2010, you made a ton of money because you got in at the bottom of the market. REITs can be very volatile.”
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