Are REITs as risky as stocks?
Compared to other investments such as stocks and bonds, REITs are subject to various risk factors that affect the investor's returns. Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.
In general, no. Although investing in REITs does carry risk, data suggests that REITs are less risky than stocks both in the short term and in the long term. As always, past performance does not guarantee future performance, but the data we have on hand is still quite promising for would-be REIT investors.
More than a year of interest rate hikes by the Federal Reserve pushed down returns on real estate investment trusts, or REITs. While higher rates negatively impacted nearly every sector of the economy in 2022 and most of 2023, real estate was hit especially hard.
Here are some of the main disadvantages of investing in a REIT. Market volatility: Value can fluctuate based on economic and market conditions. Interest rate risk: Changes in interest rates can affect the value of a REIT.
Publicly traded REITs offer investors a way to add real estate to an investment portfolio or retirement account and earn an attractive dividend. Publicly traded REITs are a safer play than their non-exchange counterparts, but there are still risks.
Any increase in the short-term interest rate eats into the profit—so if it doubled in our example above, there'd be no profit left. And if it goes up even higher, the REIT loses money. All of that makes mortgage REITs extremely volatile, and their dividends are also extremely unpredictable.
Summary of Why Investors May Not Want to Invest in REITs
But, REITs are not risk free. They may have highly variable returns, are sensitive to changes in interest rates, have income tax implications, may not be liquid, and fees can impact total returns.
REITs historically perform well during and after recessions | Pensions & Investments.
REITs have typically enjoyed strong absolute and relative total return performances after monetary policy tightening cycles end. The valuation divergence between REITs and private real estate will likely converge in 2024, making REITs an attractive option for investors.
Bottom line. Investors eyeing REITs may find a potential recovery ahead. With rate cuts on the horizon, many publicly traded REITs have rebounded, and the industry as a whole seems well-poised for a recovery in the coming year.
Are REITs a good investment in 2023?
However, our review of REIT balance sheets and debt suggests that REITs are well-positioned for economic uncertainty in 2023 because of their strong balance sheets. They are entering the new year with leverage near historical lows, and well-termed, mostly fixed-rate debt and very low current interest expense.
Though REITs have typically experienced relative total return underperformance during Fed tightening cycles, they have outperformed both private real estate and equities in post-rate hike periods. With the Fed at or near the end of its interest rate hike cycle, this bodes well for 2024 REIT performance.
While both REITs and bonds have enjoyed lower volatility compared to stocks, bonds are the lower volatility asset class due to their much lower correlation with stocks. Meanwhile, REITs can experience significant share price volatility, especially over short periods of time.
To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.
Direct real estate investments may be more expensive upfront but give investors increased control and flexibility. Both real estate and REITs can help investors hedge inflation and market downturn risks. Both can also be a source of regular cash flow, though REITs are a much more passive investment than real estate.
The majority of REIT dividends are taxed as ordinary income up to the maximum rate of 37% (returning to 39.6% in 2026), plus a separate 3.8% surtax on investment income.
This is the biggest and most important mistake that REIT investors keep on making. They see REITs as "income vehicles" and therefore, they will select their investments based on their dividend yield. In their mind, the higher the better. But in reality, the dividend is just a capital allocation decision.
While it is true that the underlying assets of a Real Estate Investment Trust (REIT) typically cannot go to zero, it is still possible for a REIT to go bankrupt. This can occur if the REIT takes on too much debt, mismanages its properties, or faces significant legal or regulatory issues.
Investors can benefit from allocating as little as 5% to REITs. Investor confidence in real estate reached unprecedented levels in 2022, owing to home price appreciation and higher yields for other asset classes, such as REITs, in low-rate environments.
Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making. Many REITs are publicly traded on exchanges, so they're easier to buy and sell than traditional real estate.
Does Warren Buffett invest in REITs?
While real estate has never been a big part of Buffett's investing strategy, Berkshire Hathaway has owned shares of STORE Capital, a REIT focused on single-tenant operational real estate.
Historically, REITs Have Protected Against Inflation and Rising Interest Rates. Given current conditions, it is important to recall that REITs have proven to perform well in past inflationary environments.
According to the data, REITs have outperformed stocks over the long term, delivering an 11.9% average annual return from 1972 to 2021 (compared to 10.7% for the S&P 500). At that rate of return, a monthly investment of $300 in REITs would grow into $1 million in about 30 years.
Investing in REITs can add some diversification to your portfolio and give you access to passive income, liquidity and excellent long-term returns. However, taxes can be more expensive with REITs compared to other investment options, and there are still risks involved with the real estate market.
There is no set lifetime for the trust in most cases. Investors who buy publicly traded shares in a REIT can usually buy as much or little as they like and dispose of the shares when they want or need to.
