Updated Friday, August 1, 2014 as of 7:51 AM ET
The Case for REITs as Alternatives
Monday, July 7, 2014
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Real Estate Investment Trusts (REITs) are often viewed as alternatives, though Morningstar doesn’t characterize them as such, since they are now mainstream. Though private, non-traded REITs have very high loads and ongoing expenses, low-cost REITs can have a place as alternatives in our clients’ portfolios.

REITs performed spectacularly during the internet bubble but, of course, horribly during the more recent real estate bubble. How they will perform during the next market downturn is anyone’s guess. However, a recent 10-year forecast by Vanguard predicts REITs will earn an expected 6.2% annually with a 14.2% standard deviation.  This compares to an expected return for U.S. equities of 7.7% annually with a 17.2% standard deviation. The real benefit from REITs comes from their lower 0.6 correlation.

To be sure, a negative correlation means a likelihood REITs will go up when stocks go down. Unfortunately, the only asset classes with negative correlations to stocks also have negative expected returns. 

But we can look to the recent past to show the benefit of REITs. Over the past five years, the Vanguard REIT Index Fund (VGSLX) earned 22.3% annually, while the Vanguard Total Stock Index Fund (VTSAX) earned a similar return of 19.4%. The similarity by year wasn’t as strong with stocks besting REITs by over 30 percentage points in 2013. But this year, as of May 18, 2014, REITs are topping stocks by nearly 15 percentage points. Thus, a balanced portfolio smoothed out some returns even though correlations were positive. 

Allan S. Roth, a Financial Planning contributing writer, is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He also writes for CBS MoneyWatch.com and has taught investing at three universities.

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(3) Comments
Alan Let me offer you a couple of points on REITs. Public but non-exchange traded REITs are not private...they are public. Private REITs are another animal altogether and require one be an accredited investor to buy shares.

REITs as an Alt? Seriously? They've been mainstream as portfolio diversifiers for about 15 years now. And they did horribly in the 90's, primarily due to overbuilding and the lack of interest in just about any investment that returned less than 10%/yr.

And the non-exchange traded REITs have been unmitigated disasters to individual investors over the past 10 years. I can't think of a 'legal' investment that has lost investors...principally new retirees looking for reliable ncome...faster than these unlisted REITs. Exchanged traded REITs, of which I've held many over the past 20 years, have, as a whole, done quite well. Yes, about 80% of equity REIT dividends got cut in the 2008/09 market decline, but most dividends have recovered well, as REITs are unique in that during a recession, the demand for premium commercial space will only drop temporarily...unlike most products and services that usually do not recover as well.

REITs should be a staple in any diversified portfolio. There is nothing new about these...to most.

BruceM

Posted by Bruce M | Saturday, June 07 2014 at 3:16PM ET
Your blog provided us valuable information to work on. You have done a marvellous job! Please keep on posting such quality articles,
Posted by Jonas S | Thursday, June 12 2014 at 12:26AM ET
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Posted by James S | Tuesday, June 17 2014 at 4:28AM ET
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