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Real Estate Investing: Public and Private

FORECASTS & TRENDS E-LETTER
by Spencer Wright

November 26, 2024

IN THIS ISSUE:

Real Estate is a Very Big Sector
The Benefits and Risks of REITs
Public and Private REIT Investing
Final Thoughts
AI Thanksgiving Fun

 

This letter is the second installment in our series on alternative investments. You can find the first in the series here and an overview of alternative investments in a previous letter here.

Real estate is a very big sector and probably the best known of the alternative investment group to retail investors. How big is the real estate sector? Well like many things, that depends from which angle you are viewing it. The real estate sector is generally broken down into three segments: residential, commercial and industrial.

Real Estate is a Very Big Sector

The size of the real estate sector is staggering in dollar terms. The US residential real estate market is the largest asset class in the country with a total value of about $47 trillion. The global industrial market is about $21 trillion. The commercial real estate market in the US is approximately $12 trillion in size and the global commercial real estate market is a massive $37 trillion.

The sheer size of the real estate sector creates an incredible number of investment possibilities. I am sure many of our readers own investment properties, such as a vacation home, single- or multi-family units or property they plan to develop in the future. For our discussion today, we will focus on a real estate investment called a REIT – a Real Estate Investment Trust.

REITs offer a low-cost way to invest in the real estate market without having to directly own and operate properties. REITs can be public or private investments. If we consider just the US REIT market, it is valued at approximately $253 billion.

The Benefits and Risks of REITs

The principal benefit of having REITs in a portfolio is diversification. Morningstar recently published a paper on the effect of REITs in a portfolio. The paper produced some interesting information. Consider this graphic that details the role of REITs in a mixed asset portfolio.

Graph showing REITs should be in a mixed asset portfolio

Nearly 75% of experts conclude that the presence of REITs in a portfolio is an effective diversification tool over the long term.

Real estate returns are unlike those of stocks in part because:

  • Their returns are primarily generated from income.
  • At least 90% of a REIT’s taxable income must be distributed to investors in terms of dividends.
  • REITs tend to offer higher dividends.
  • REITs tend to follow real estate cycles, which last on average almost twice as long as bond and stock market cycles.
  • The property market is highly segmented, which allows investors to diversify by real estate trends.

The following charts illustrate that many index funds are under allocated to REITs relative to the percentage of REITs in the index. This is despite REITs having a long period of favorable performance.

Graph showing most index mutual funds have little exposure to REITs

Owning an index fund does not automatically give you notable exposure to all sectors in that index. This is why having a discrete REIT allocation can still add value at the portfolio level.

If you include a REIT allocation in your portfolio the next obvious question is, how much? Of course, that depends a great deal on your individual situation and risk tolerance. Here is a chart that illustrates allocations of 5%, 10% and 15% to REITs benchmarked against a standard 60/40 portfolio without REIT allocations.

Graph showing what REITs in a portfolio will do to returns

As you can see, REITs have been additive over the long haul, especially during periods of market stress when traditional equity and bond investment can struggle.

As mentioned, REITs can pay higher dividends than traditional equities and bonds. Commercial REITs can serve as a potential hedge against inflation as they often have agreements that allow them to raise rents in line with inflation.

As with all investments, REITs carry risk. The specific type of risk will depend on the type of REIT but there are some general risks that apply to most.

REITs are subject to interest rate risk. When interest rates rise, the cost of borrowing goes up. Since many REITs rely on debt to finance their properties, this can potentially impact their profitability and dividend payouts. It can also affect property value and occupancy demand.

Geographic risk is also a concern. If a REIT is heavily exposed to a narrow geographic area or region, it could have a negative impact on performance if that region experiences trouble in its real estate market.

Residential and commercial REITs are especially subject to occupancy risks. If occupancy drops below a certain level, the REIT may have trouble maintaining historical payouts. Lower rents and occupancy rates can have a very negative impact on REITs.

Public and Private REIT Investing

REITs are available to investors in both public and private marketplaces. They are referred to as listed (Public) and non-listed (Private) REITs. Both public and private REITs can invest across a very wide range of real estate. Some have broad portfolios that cover the main real estate sub-sectors but some are very focused on only one or two sub-sectors. While focused REITs may offer higher returns and or payouts, the returns often come with more risk.

Listed REITs are traded on exchanges and are fully liquid, which is generally advantageous to individual investors. However, listed REITs can be subject to general market risks. Price fluctuations in the broad markets brought on by macro events can also affect REIT pricing, even it those events are not related to the real estate sector.

Non-listed REITs are generally insulated from such macro market shocks but almost always have limitations on “liquidity” – when you can redeem shares. The level of illiquidity can vary greatly between REITs, some as much as a year or more. Non-listed REITs can also “gate” or limit the amount of withdrawals. As with any private fund, ask for a liquidity schedule when considering an investment.

Final Thoughts

REITs are a useful portfolio tool for diversification. They can provide income and capital appreciation. There are many different types of REITs with a wide variety of investment focus. Of course, like all investments, REITs are not right for all investors. Consult a financial professional to determine if an investment in REITs is right for you.

AI Thanksgiving Fun

I had to ask the Microsoft AI, Copilot, to render a picture for the prompt, “A happy AI Thanksgiving.” Behold the result:

AI-generated picture of a robot with a turkey dinner

Thanks for reading and Happy Thanksgiving,

 


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Forecasts & Trends is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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