Depends!

Investing in real estate has become increasingly popular over the last fifty years. Considering the general rise in property prices over the last few decades in the U.S., and around the world, it is not surprising that investors are chasing returns generated from investing in real estate through REITs.

What are REITs?

A real estate investment trust (REIT) is one form of an investing vehicle intended to make money from investments in real estate. REITs are created when a trust (or corporation) uses funds from investors to purchase and operate income properties. REITs develop and manage real-estate and commercial properties including hotels, public storage units, office buildings, factory outlets, shopping centers, and apartment complexes. REITs are bought and sold on the major exchanges similar to publicly traded corporations.

Why invest in REITs?

There are several reasons why investors prefer to invest in REITs (or REIT funds). First, REITs must pay out 90% of its taxable profits in the form of dividends to retain its status as a REIT. The advantage is that, by doing so, REITs avoid paying corporate income tax. In contrast, regular public companies are taxed twice, once when it earns a profit and then again when it decides to distribute its after-tax profits as dividend. Thus, if you invest in REITs, you avoid the so called “double taxation” of income. Second, because of the 90% distribution requirement, dividend yields are high for REITs which is a key reason why investors seeking income invest in REITs. Third, real estate, as an asset class, often shows low correlation with other types of stock or bond investments. Therefore, real estate is needs to be added to a portfolio for diversification reasons.

REITs and Long-term performance

Take for example Vanguard REIT Index Fund which has one of the lowest, if not the lowest, expense ratios of the different types of funds investing in REITs. The Vanguard REIT Index Fund has assets totaling almost $53 billion invested in 155 different holdings. The fund has generated a return of 11.65% over the past five years and 7.44% over the past decade.

REITs and Short-term performance

2014: You would have made staggering returns, on an absolute and relative basis, if you invested in a REIT in 2014. The Fund generated a total return of 30.13%. In contrast, the return on S&P 500 stocks was only 13.69%. Therefore, you earned more than twice than the market when investing in real estate in 2014.

2015: You would have made dismal returns if you invested in a REIT. Vanguard REIT Index Fund generated a total return of 2.31%. However, if you held REITs for two years (2014-2015), you would have beaten the market (the average return would have been around 15%-16%).

REITs and the Future

The real estate sector is highly sensitive to interest rates. Future REIT fund returns might be adversely affected as the underlying businesses grapple with higher interest payments. If you expect interest rates to rise this year, REITs may not be your top performer but one that will still give you high dividend if you seek extra cash flow. 

Are you still betting on the real estate this year?

http://money.usnews.com/funds/mutual-funds/real-estate/vanguard-reit-index-fund/vgsix

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