REIT Primer: Should You Add REITs To Your Retirement Portfolio?

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empireHere is a fairly balanced and informational Morningstar article about real estate investment trusts (REITs). Below are my notes and excerpts:

  • Equity REITs are publicly traded companies that own and manage income-generating real estate properties. REITs are required to distribute at least 90% of their income to investors, which allows them to avoid paying corporate taxes. The bad news is that most of their distributions are taxed as ordinary income.
  • In order to further improve diversification, investors can hold a portfolio of REITs through a low-cost fund, like the Vanguard REIT ETF (VNQ). (This is how I hold my REITs, via the mutual fund equivalent VGSIX and VGSLX.)
  • REITs represent about 3.6% of the CRSP US Total Market Index, which tracks the entire U.S. investable equity market on a market-weighted basis.
  • Much like homeowners with mortgages, REITs buy properties using debt financing. This leverage amplifies both gains and losses in real estate values and increases share price volatility. In other words, REIT values will be a lot bumpier than just estimated your home’s resale value whenever a neighbor sells their house.
  • From 1972 through September 2014, the FTSE NAREIT All Equity REITs Index generated a 12% annualized total return, while the S&P 500 posted 10.5%.
  • Nearly two-thirds of the REIT index’s return from 1972-2014 came from distributions, which are largely derived from rental income. Investors should have modest expectations for capital gains.
  • REITs have historically not been a good hedge against inflation in the short term. As noted, long-term returns are significantly above inflation.
  • Current REIT valuations as of November 2014 are considered relatively high by traditional metrics.

Random fact: Did you know you can buy partial ownership of the Empire State Building in New York City via the Empire State Realty Trust (ticker ESRT)? You’d be collecting rent from some big name tenants. ESRT currently makes up about 0.17% of the Vanguard REIT Fund, so if you own VNQ you also own a tiny piece.

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  1. 0.17% is significant how. The body of your post works. Last paragraph is meaningless and will confuse readers.

    • It’s a random fact, thrown in for fun. 0.2% is not meant to be significant, but it does show that if you own VNQ, you in fact own a tiny portion of the Empire State Building. Perhaps an elevator button or something. 🙂

      • Jonathan,

        Maybe not everybody likes to have fun 😉

        But your last comment was very spot on, since you are essentially saying that by owning VNQ, you own a tiny slice of real buildings out there, not some sort of lottery ticket whose price blinks on a screen. VNQ owns real businesses that own real estate, which they rent out and generate cash to pay dividends. With each share of say ESRT you buy, you own a slightly higher portion of the Empire State Building (and the other properties ESRT owns). This is how intelligent investors should think, and I applaud you for that!

        Dividend Growth Investor

  2. I personally thought the last paragraph was really interesting. It makes sense that you could own part of the Empire State Building, but I guess I just never thought about it.

    As far as REITs, I have always considering adding them to my retirement portfolio, but I keep telling myself that since I own some rental property, that’s enough. I would like to have more real estate in my portfolio though and REITs may be how I approach doing that.

    Do you have any in your portfolio, Jonathan?

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