With 10-year US Treasury yields hovering near record lows, many investors seek assets offering them a higher yield. One common investment many investors tend to consider: Real Estate Investment Trusts (REITs), which typically feature higher yields than broader markets. In Fisher Investments’ view, while having some REIT exposure in your portfolio is fine, it is important to understand what you own and also scale your holdings to avoid overconcentration. Chasing yield could otherwise greatly increase risk.

REITs are effectively real estate companies that pool investors’ assets to buy property-related investments such as apartment buildings, offices, malls or data centers, for example. Alternatively, some REITs own mortgages, seeking to capture the spread between the rate they earn on the mortgage and their funding costs. REITs commonly pay higher dividend yields largely because they fall under a special subsection of the tax code. To qualify, a REIT must distribute 90% of its taxable income to shareholders. The REIT can deduct these dividends dollar for dollar against corporate income, allowing many REITs to pay no corporate income tax. Effectively, the structure incentivizes them to pay high dividends while shifting the tax burden to shareholders. Hence, it is no surprise index provider FTSE’s Nareit US Equity REIT Index sported a 4.17% dividend yield as of July 31, 2020. On the same day, the S&P 500’s return was 1.79%, while US 10-year Treasurys paid just 0.55%.

Leaving aside the type of investments the REIT makes, the largest distinction—and a key one investors should weigh, in Fisher Investments’ view—is whether the REIT is publicly traded (meaning, listed on a stock exchange) or non-traded. REITs come in both flavors, but we think there are clear benefits to the publicly traded variety. For one thing, non-traded REITs typically have steep upfront fees. According to the brokerage industry’s self-regulator, FINRA, these fees can be as high as 15% of the initial investment. If you buy a publicly traded REIT, you may pay only a trading commission, which would be far, far smaller. Buying a newly listed REIT at issuance can be pricier, but this situation is relatively uncommon.

But the bigger issue with non-traded REITs is their lack of liquidity. Because they aren’t listed on an exchange, they can be difficult to sell, should you need or wish to. Many non-traded REIT investors seeking to sell often are forced to accept deep discounts to the price listed in their brokerage account statement. So, after paying a potentially high upfront fee to complete the purchase, investors may pay a high cost exiting, too. In Fisher Investments’ experience, many investors overlook these drawbacks on the notion non-traded REITS are less volatile. But their lack of price movement is due largely to their lack of liquidity—and, in our view, this is a key risk investors must weigh. We think it is very often quite difficult to justify buying a non-traded REIT versus a publicly traded one, which can be bought and sold in the market similar to any stock.

Even listed REITs are, of course, not risk free or devoid of drawbacks. For one thing, while many seem to draw distinctions between listed REITs and stocks, they tend to behave in near-identical ways. Investors owning listed REITs should understand they tend to trade similarly to small cap value stocks like regional banks, according to Fisher Investments’ research. Over the last 20 years, the correlation coefficient between US small cap Financials stocks and publicly traded REITs is 0.84. Considering 1.00 means identical movement and -1.00 exact opposite, this shows REITs and small bank stocks tend to move in the same direction, albeit to varying degrees. This high correlation to bank stocks also showed in 2007–2009’s financial crisis, when REITs vastly underperformed broad equity markets.

Also, if you hold REITs in taxable investment accounts, know REIT dividends are taxed differently than those of common stocks. While common stock dividends may qualify for lower 15% or 20% rates, REIT dividends are typically taxed at your ordinary income bracket. Remember: The REIT didn’t pay corporate tax on the income it generated. They pushed that tax obligation to you. Depending on your tax bracket, that may water down the perceived “edge” a higher dividend yield may otherwise carry.

Still, there is a place for REITs in a diverse portfolio. If you expect value-oriented stocks to outperform, it is possible overweighting REITs could make sense. That said, REITs amount to just 3.3% of the broad US market. If you are holding much more than this in your portfolio, you could easily be over-concentrated, increasing risk.

The lesson of the current low-yielding environment, in our view, isn’t to seek out higher-yielding equity categories like REITs—and non-traded REITs are an even worse answer. To us, the lesson is to avoid focusing on yield alone. Instead, look to total return. Realize that you could sell pieces of stocks and bonds you hold to fund your retirement needs. That way the price movement plus the yield meets your cash-flow needs.

Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein. Fisher Investments does not offer tax advice. Please consult a tax adviser for tax reporting purposes.

[i] Source: FTSE, as of 08/12/2020.
[ii] Source: FactSet, as of 08/12/2020.
[iii] “Public Non-Traded REITs—Perform a Careful Review Before Investing,” Staff, FINRA, November 30, 2016.
[iv] Source: FactSet, as of 08/12/2020. Correlation coefficient between the FTSE REIT Composite Index and MSCI USA Small Cap Financials sector, calculated using weekly returns, 08/04/2000–07/31/2020.
[v] Source: FactSet, as of 8/12/2020. REIT percentage of MSCI USA IMI market cap. The MSCI USA IMI Index is a broad gauge covering 99% of all investible stocks in the US

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