Time to Revisit REITS!
Jesse Redmond
Former Hedge Fund Manager | Dispensary Operator | Cannabis Analyst | Now Building LEEF Brands
Main street investors have historically attempted to diversify their portfolios using a combination of stocks and bonds. Liquid alternatives are a relatively new set of strategies designed to provide unique return streams with low correlation to stocks and bonds. Real Estate Investment Trusts (REITs) are one type of liquid alternative investment that embed the potential for profits when interest rates rise.
REITS were created by an act of Congress in 1960 enabling investors to participate in the rental income proceeds from commercial properties. They trade on major exchanges, just like shares of stock. They typically own rent-producing real estate (shopping malls, office buildings, apartments, warehouses and hotels) and, due to their tax status, are required to distribute at least 90% of their income directly to shareholders. This means most REITs have high yields, making them an attractive alternative to bonds, especially in the current ultra-low interest rate environment.
A critical distinction is REITs have provided a hedge against inflation, while bonds lose money when interest rates rise. From 1976-2014, REITs generated real returns (nominal returns less inflation) of 10.06% annually, compared to 7.62% for stocks, and 3.92% for bonds. The real returns of REITs were slightly more volatile than stocks, with a standard deviation of 17.50% compared to 16.83% for stocks, but REITs provided greater returns per unit of risk.
In addition to providing compelling absolute and risk-adjusted returns, REITs have provided excellent diversification. From 2002-2015 the rolling 90 day rolling correlation between U.S. REITS and U.S. Bonds was -0.13.
It's not a matter of if interest rates are going up, it's a matter of when. To mitigate the damage when rates rise, don't just premptively sell your bonds or other rate-sensitive holdings. Consider alternatives like REITS — where there is profit potential when rates go up. Do your homework, analyze your portfolio, and I'll be surprised if an allocation to REITS doesn't help protect you from higher interest rates and provide a nice income stream along the way.