Looking for a good investment in 2018? Consider real estate investment trusts (REITs). REITs are composed of commercial properties. Investors who purchase them are often buying a basket of commercial properties, which can include apartment complexes, office buildings, hospitals, shopping centers, warehouses and more.
However, REITs are analogous to a mutual fund in that they are listed on major stock exchanges under ticker symbols. They can be purchased and sold as easily as stocks. Just as you are purchasing shares of a company when you buy stocks, you are purchasing part of a group of commercial properties when purchasing a REIT.
REITs are managed by real estate asset managers whose goal is to derive financial value from the real estate investments. They may be property managers or be engaged in the whole property lifecycle, including lease review during the initial acquisition, property management, etc.
There are several reasons REITs should reward investors over the next 12 months.
1. High yields
By law, REITs must distribute at least 90% of their income stream to investors every year. Many distribute 100% of their income.
As a result, investors receive a very high yield annually from their REIT holdings. REIT distribution yields are often 8-9%, and can be as high as 12% or more. These yields are far above yields on bonds or certificates of deposit.
2. Portfolio diversification
By owning REITs, investors are invested in real estate. For investors who are also holders of stocks or bonds, REITs provide portfolio diversification.
Portfolio diversification may be an especially smart move this year because of the strong performance of the stock market over the past 13 months. The broad stock market averages in the U.S., such as the Standard & Poor’s 500 and the Dow Jones Industrial Average (DJIA) increased dramatically during 2017. Stock markets had one of their best years ever.
However, no stock market goes up year after year without pulling back. At some point, it is likely that stocks will correct. Stock market investors will likely see at least some declines in their equity portfolios when that happens, for the duration of the correction.
REIT investments provide portfolio diversification, so equity investors are also invested in real estate and in instruments with high dividend yields.
Even if the stock-exchange-traded price of REITs falls in sympathy with a broad market correction, the yield will rise even higher, as yields are a percentage of the REIT price. A REIT selling at $50 with a $5.00 distribution, for example, will yield 10% to investors. If the REIT price falls to $45, though, the distribution’s yield will become 11.1%.
3. Share price appreciation potential with lower volatility
In addition to high yields, the price of REITs advances and declines. When it advances, investors get the benefit of share price appreciation.
However, REITs usually have much lower volatility than the stock market. While they may rise less in a bull market, they also fall less during market corrections. Investors who fear this may be a choppy year on the stock market will find less volatility with REITs.
4. Strong outlook for commercial real estate
In general, when the economy is strong, commercial real estate does well. Businesses expand when the economy is strong, which increases the ability of property managers to raise commercial rents. It also causes more robust rental rates and can decrease any vacancy rates.
The economy was very strong in 2017, with high employment and good business expansion. A robust economy looks very likely to continue in 2018. The stronger the economy, the better for REITs.
That said, investors should keep an eye on the areas their REIT properties are in. Some areas of the U.S. have very low to zero vacancy rates and very high rents, such as the coastal cities of New York City and San Francisco. Other areas, such as the industrial Midwest, have larger vacancy rates and less ability to raise rents. The performance of any REIT will vary according to the economy of its area.
5. High Predictability and Stability
While the stock market has gone up reliably on average since the 1950s, the performance of individual years is never, of course, entirely predictable. The performance of the stock market depends on many factors, including the robustness of individual company earnings, the political outlook, regulation and more.
Real estate, by contrast, has much greater predictability. Rents in a given set of leases are stable, so they provide predictability. REIT asset managers can generally predict performance both in the short and long term. Because performance is predictability, it is also more stable than the stock market.
This year is a good one to invest in REITs. They offer higher yields than either bonds or certificates of deposits, portfolio diversification and the opportunity for share price diversification with low volatility. The economy is strong, which means the outlook for the commercial real estate that REITs invest in is also strong.
