Since Vintage was founded in 1985, we’ve always allocated some of our client’s funds to real estate investments. The allocations have changed based on our outlook for the investment class and our client’s situations. Today, we have a larger allocation than usual, especially for our retired clients.
If we look back throughout US history, it seems that Americans have built significant wealth by investing in either successful companies or real estate. Stocks offer a great way to passively invest in companies while Real Estate Investment Trusts (REITs) offer a good way to invest in real estate.
Individual REITs typically focus on a particular type of real estate such as office buildings, apartments, retail or hotels. Some others may invest in self storage, cell phone towers or data centers. They collect rents that they pay out in dividends and try to focus their portfolios on properties that will show some good appreciation, too.
REITs differ from a typical corporation in that they can avoid a corporate income tax if they pay out at least 90% of their income to their shareholders as dividends. This makes them a good investment for retirees that may be seeking income. Unlike bond interest, REIT dividends tend to increase over the years as rents rise.
Historically, real estate has also offered good diversification from stocks and bonds. It has tended to go in its own cycle and is impacted by interest rates, inflation and the economy a little bit differently than stocks. While REIT returns have been similar to stocks over the past couple years, the chart below shows how the returns normally have varied significantly from year to year.
The returns on REITs over the last few decades have been excellent and have often topped the S&P 500. Over the past ten years, US stocks have had an excellent run with the average large cap blend stock fund earning an average of 11.4% annually according to Morningstar (figures through 6/12/20). The average real estate fund earned 8.5% per year over that period, well ahead of the average intermediate term core bond fund that gained just 3.7%.
Source: Morningstar for period through 6/12/20
Most money management firms typically diversify their client’s portfolios among stocks and bonds and maybe some cash. But as we look at the investment markets today, we see real estate as a much more attractive investment than the higher quality bonds.
The future is always uncertain, but today it seems much more so with the threat of COVID-19 hanging over the global economy. The US government and Federal Reserve Bank have generated an unprecedented amount of fiscal and monetary stimulus that may buoy the economy in the short term but may have unintended consequences in the years ahead. Should inflation and/or interest rates rise, the higher quality bonds will be lousy investments and will likely show inflation adjusted losses even if rates remain stable. Real estate not only offers dramatically higher cash yields today, but it has historically done well during inflationary periods.
Today, we think the question investors should be asking is not “why real estate?”, but “why invest in high quality bonds?”.
