Taking Stock: REITS
For years, real estate investment trusts (“REITS”) rewarded investors with consistent dividends (averaging 5-7%), relatively low volatility and low correlation to other asset classes. Starting in 2008, however, the experience of the REIT investor changed significantly.
From its inception in 1990 until the end of 2007, the Dow Jones All REIT index moved more than 5% in a single day only three times. Yet, in the seven months from September 2008 to March 2009, value changes of that magnitude occurred a staggering 64 times, and REIT values plummeted over 70% from their 2007 peak. But over the last year, REIT values have more than doubled, and volatility has declined, though it remains elevated relative to historical levels. In addition, the average dividend of US REITs, at approximately 4%, is still well below the long-term average.
These dramatic changes in the REIT market over the past two years raise the question of whether there has been a permanent change in the investment characteristics of REITs. In particular, can we expect REITs to provide the benefits of portfolio diversification and yield as they had prior to the last couple of years?
One view is that, at the end of 2008 when the credit crisis was peaking, the outlook for commercial real estate was darkening by the day, and as values started to free fall, investors actually began to question the fundamental viability of the REIT business model itself. But in a stunning turnaround, global REITs successfully raised over $55 billion in debt and equity in 2009, substantially de-levering their balance sheets and quieting critics. Further, through these capital infusions many REITs were able to develop substantial cash “war chests,” putting them in an enviable position to acquire distressed assets at attractive prices. REITs appear to have demonstrated their staying power while making the case that their access to inexpensive capital…in a credit constrained environment…gives them a distinct advantage over private real estate investors. Although dividend yields are currently low on an absolute basis, they are reasonably attractive relative to current fixed income yields and REIT dividend yields are likely to increase as REITs make accretive acquisitions in the near term, and over the longer term, grow net operating income as the economic recovery improves fundamentals.
Others argue, however, that in the future, REIT performance is likely to become more highly correlated with other asset classes and dividend yields will remain low due to structural and technical changes. The rise of REIT-focused Exchange Traded Funds (“ETFs”) has created a surge in trading activity, while the investor base of REITs has evolved from primarily individuals to primarily institutions. In response, REIT management teams may shift their emphasis from generating dividends to capital appreciation to reflect the interests of their new ownership base.
Although we see some merit in both perspectives, we believe the investment case for REITs over the medium term remains compelling even if volatility remains above average. As noted earlier, REITs’ access to the public capital markets should give them a competitive edge going forward to make accretive acquisitions. In addition, investing in a global REIT portfolio, as Aspiriant generally recommends, provides geographical and currency diversification, which should be enhanced as more countries adopt the REIT structure to encourage more transparency and liquidity in their national real estate investment markets. Further, history indicates that a real estate recovery typically lags economic growth. Once global economic fundamentals improve, which we expect to occur first in Asia and Latin America, then the United States, and finally Europe, dividend growth is likely to resume as well.
The Aspiriant investment strategy team believes REITs remain an important part of a well-designed portfolio, providing diversification, an inflation hedge, and exposure to domestic and international real estate markets. As such, we have maintained global public real estate exposure generally constant across client portfolios