You ask your son to pass the salad. He lifts the bowl as your cellphone rings. Taking calls during family dinners isn’t really your thing. But your tenants have an emergency. A pipe broke in their bathroom and the place is starting to stink. No surprise here—you’ve just lost your appetite.
Many people have plenty of luck buying a second home and renting it out. Others battle. Sometimes, it’s a dishonest property manager. It could be a loopy, destructive tenant. A marijuana grow operation could be thriving in your basement.
Like any investment, real estate comes with risks. It also comes with hassles. Investors who want exposure to property without the PITA (Pain-In-The-Ass) factor have an alternative. They can buy an index of Real Estate Income Trusts.
REITs are real estate companies that buy income-producing properties. Some focus on hospitals. Others focus on office buildings, shopping malls or warehouses. They collect rents from tenants, as you would with a second home. But nobody bugs you—ever.
REITs trade on the stock market. Funds of REITs, as with traditional stock market funds, can be actively managed or passive. But it’s best to go with an index. They charge lower fees. That puts more money in your own pocket, less money in Wall Street’s.
Dividend payouts tend to be higher than they are with common stocks. That’s because REITs must return 90 percent of their income to investors. This could be attractive for yield hungry folks. Vanguard’s S&P 500 index paid a dividend yield of just 1.92 percent over the past 12 months. Vanguard’s High Dividend Yield Index, which isn’t a REIT, yielded 3.04 percent. But Vanguard’s REIT Admiral Share Index fund yielded 3.92 percent.
Historically, REITs and traditional stocks battle like Ali and Frazier. Sometimes REITs win. Other times, traditional stocks knock them out.
Between 1996 and 1999, stocks pounded REITs into a corner. Between 1999 and 2002, REITs reigned supreme. REITs then outclassed stocks for the next five years. But when the financial crisis arrived in 2008, both hit the canvas. Fortunately, traditional stocks and REITs are now squarely on their feet.
The past isn’t a prologue. But here’s how Vanguard’s REIT index has compared with the S&P 500 over the past 19½ years.
Vanguard’s REIT Index vs. Vanguard’s S&P 500 Index
May 13, 1996 to November 6, 2015
A $10,000 investment in Vanguard’s REIT index, with all dividends reinvested, would have grown to $74,260 between the fund’s inception date (May 13th 1996) and November 6, 2015. That’s a compounding annual return of 10.8 percent per year.
By comparison, $10,000 in Vanguard’s S&P 500 would have grown to $45,467 for a compounding annual return of 8.1 percent.
Over the past 10 years, their rounds have been tighter. Each has averaged a compounding return of about 7.8 percent per year.
Vanguard’s REIT Index vs. Vanguard’s S&P 500 Index
November 1996 to November 2015
By adding real estate to a portfolio of stocks and bonds, investors might enhance returns, while decreasing volatility. Using data from Standard & Poor’s, Barclays and Gerstein Fisher Research, Forbes contributor Gregg S. Fisher gave two historical portfolio scenarios. By investing 60 percent in U.S. stocks and 40 percent in U.S. bonds, he found a portfolio would have averaged a compounding return of 8.72 percent between January 1990 and October 2014.
If, however, investors had added a 10 percent overall allocation to global REITs, compounding returns would have improved to 8.83 percent per year. The portfolio, with REITs, would have also been less volatile.
Fisher also checked different rolling 10-year periods. For example, how did they stack up between 1990 and 2000? How did they compare between 1991 and 2001? Did he find different results between 1992 and 2012? Fisher writers, “In about 80 percent of rolling 10-year periods the portfolio with [10 percent real estate added]…achieved a higher return; volatility was lower in about 65 percent of the same periods.”
If you want global exposure to real estate, check out the iShares Global REIT ETF Sixty-five percent of its holdings are made up of U.S. REITs. The remainder is international. Its annual fees are just 0.14 percent, and its trailing 12-month dividend yield was 3.89 percent.
Whether you invest in REITs or not, remember just one thing. Diversification is smart. At some point, a lopsided portfolio will stink like a broken toilet.
Globally Balanced Portfolio Sample
Including Global REITs
|Allocation||ETF||Expense Ratio||It’s invested in…|
|10%||iShares Global REIT ETF||0.14%||Global Real Estate Income Trusts: 65% American; 35% International|
|55%||Vanguard Total World Stock Market ETF||0.17%||Global stocks: 52% American; 48% International, including developed and emerging markets|
|35%||Vanguard Short-Term Inflation Protected Securities ETF||0.10%||Bonds backed by the U.S. federal government; adjusted quarterly, based on inflation|
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.