When Dwight David Eisenhower signed the Cigar Excise Tax extension in 1960, he created a structure to allow Real Estate Investment Trusts (REITs) to begin trading on public markets for the first time. That action was heralded as a game-changer for the real estate industry. Until then, real estate investing was solely done on a private basis by high-net-worth investors buying real property.
REITs further expanded in the 1990s as more operating companies took advantage of the public markets after Congress passed The Tax Reform Act of 1986. Since then, REITs have become a global industry and are available worldwide. U.S.-based REITs account for about two-thirds of the worldwide market. Over time, REITs have become a significant component of global stock markets.
However, publicly-traded REITs are not the only path available to investors who want to own real estate in their investment portfolios. Private real estate, which historically has been the investment domain of institutions and sophisticated family offices, is today widely available to investors in various forms. So investors now have a choice between public and private options. We’ll look at a few of the benefits and considerations of each type.
Public REITs provide a distinct advantage to investors in the form of portfolio diversification. Many investors view REITs as “alternative investments” that are less correlated to stocks and bonds and, thus, can potentially reduce the volatility of a traditional 60/40 portfolio. However, while publicly traded REITs can improve portfolio diversification, there have been periods, like during the Great Recession, when REIT valuations moved more in lockstep with the equity markets.
Also, since public REITs trade on most global public stock markets, they provide a high degree of liquidity, enabling advisors to adjust client portfolio allocations as market conditions change. While liquidity is desirable, timing when to own or sell REITs can be challenging as their underlying assets are subject to market cycles unique to the real estate industry. As a result, it can be challenging for advisors to monitor those cycles and know exactly how they will impact a REIT performance.
Private Real Estate
Private real estate investments may also provide advisors the opportunity to diversify client portfolios, but the property valuations are not subject to the influences of public market movements like publicly-traded REITs. That is one reason why many advisors believe allocating a portion of client portfolios to private real estate is a better approach to diversification. However, it’s important to know that a private real estate portfolio may hold only one or two properties. In contrast, a public REIT may offer better diversity in its underlying holdings by owning many different asset types in different locations.
Increasingly, advisors turn to private real estate as an alternative source of income (often paid out in the form of monthly distributions) to help improve the cash flow for income-oriented clients. Advisors can undoubtedly look to different higher-yielding strategies like non-investment grade corporate bonds or dividend-paying stocks to solve the income challenges clients face today, but each option carries additional risk. Private real estate has historically generated fairly consistent returns and distributions over time as a broad asset class.
While rising inflation can have a detrimental and direct impact on the net returns of stocks and bonds, private real estate has historically held its intrinsic value because supply is often limited, especially in densely populated urban areas. And when consumer prices rise, private real estate property managers can help keep pace with inflation by raising tenant rents on the properties they manage.
Allocating a portion of your clients’ portfolios to real estate can provide several advantages. However, the decision to invest in publicly-traded REITs or private real estate will depend on each client’s specific goals and objectives. The good news is, you have many options.