Right-Sizing Real Estate Allocations | ETF Trends

The real estate sector was punished in 2022 due in large part to rising interest rates, but the group’s above-average income, diversification benefits, and inflation-fighting track record remain sources of allure.

For investors willing to allocate capital to real estate investment trusts (REITs) as a 2023 rebound wager, there are encouraging factors to consider. Those include the point that following the financial crisis in 2008, REITs prioritized balance sheet sturdiness – an effort that continues paying off for investors today.

“These structural changes to the real estate market, in addition to REITs historically rewarding investors well over the long run, have helped investors feel more confident in this asset class. Since the beginning of the modern-REIT era in 1991, REITs’ annualized returns have outperformed the U.S. stock market more than 56% of the time,” wrote Morningstar analyst Jeremy Pagan.

While publicly traded REITs are usually viewed through a lens comparable to other equities, the reality is real estate is considered an alternative asset class. As such, advisors and investors often grapple with exactly how much of a portfolio should feature real estate exposure.

That’s comparable to what market participants deal with regarding commodities and as is the case with commodities, investors can benefit from even modest real estate allocations, even as low as 5%, as Morningstar’s Pagan notes. A primary selling point with alternative assets is that they usually feature reduced correlations to bonds and equities. When that happens with REITs, investors can benefit.

“In addition, when correlations between REITs and stock returns are low, the future of REIT performance tends to be high. This allows investors to use real estate as a defensive stock during periods of economic distress and heightened market volatility,” added Pagan.

Research also confirms that investors adhering to the traditional 60% equity/40% fixed income portfolio structure without including REITs could benefit over the long term by making room for real estate, even if at a small percentage.

“Additionally, recent research found that low-risk-aversion investors (with their higher benchmark allocation in stocks) who are fully invested in a stock and bond portfolio and are considering real estate assets would obtain higher returns by including REIT common stocks, while high-risk-aversion investors would benefit in more risk reduction from REIT preferred stocks,” concluded Pagan.

Furthermore, while real estate is considered a defensive sector, some of its sub-groups have the octane to appease growth-oriented investors. Those include data centers and other tech-related REITs as well as healthcare and industrial REITs.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.