Thoughts And Articles On REITs

Scope And Purpose Of This Post

This post will be a perpetual work in progress, where I will share article, snippets, and my own thoughts about REITs, with a focus on "how much of my portfolio should be REITs?".  Currently my answer is "about what you already get with a total stock market index fund".

Article 1: The Role of REITs in a Diversified Portfolio

https://www.advisorperspectives.com/articles/2017/08/21/the-role-of-reits-in-a-diversified-portfolio

author: Larry Swedroe

• "Many investors think of real estate investment trusts (REITs) as a distinct asset class because, in aggregate, they historically have had relatively low correlation with both stocks and bonds, and their returns were not well explained by the single-factor CAPM model...The low correlation, along with the fact that the Dow Jones Select REIT Index produced a higher return (12.2%) than either the S&P 500 (11.7%) or five-year Treasury bonds (7.1%), led many investors to believe that adding REITs to a mixed-asset portfolio expanded the efficient frontier, providing superior risk-adjusted returns."
• Factors
• "Prior research had shown that, in terms of equity risk, REITs have significant exposure not only to market beta, but also to the size and value factors."
• "Demonstrating the explanatory power of the six-factor model, virtually all industries are well explained by four equity factors [beta,size,value,momentum] and two fixed income [term,credit] factors...It demonstrates that the factor model works well in explaining returns across industries, including REITs."
• heavy paraphrase: REITs showed...
• statistically significant positive exposures to {market beta, size, value, term, credit}
• insignificantly negative exposure to momentum
• "While the R-squared ratio (which measures how well the factor model explains returns) was relatively low for REITs (0.51), this was also true for other industries, including energy, utilities and health care."
• "While the relatively low correlation with the S&P 500 Index and 5YT was encouraging, the four- and six-factor regression models indicate that REITs are likely not a distinct asset class, especially when compared to the results of other industries."
• A stock/bond portfolio (small cap value equities and corporate bonds) with similar factor exposures did better (higher return, lower volatility) than REITs, and had a monthly correlation of 0.72 (not horribly high, but not very good/low either):
• "Given the factor exposures they had found, and using returns for U.S. small-cap value stocks (SV) from Ken French’s data library and the Barclays long-term corporate bond index (CORP), they attempted to replicate REITs return with these two returns series. The following table shows the results of a portfolio allocating about 67% to SV and 33% to CORP. This optimal (in the sense that it had the best fit using historical data) replicating portfolio has a monthly correlation with REITs of 0.72."
• "REITs fail to improve the mean-variance frontier, on a statistically inferred basis, when added to a portfolio holding established asset classes."; this seems important: REITs are not on the efficient frontier when you already have stocks and bonds, but perhaps by "established asset classes", they are including specific categories like small-cap value stocks?
• "unexpected monetary shocks affect REITs about twice as greatly as they affect the general equities market under high-variance regimes"
• "extreme risks for REITs generally are higher than those of nine non-U.S. stock markets they studied, and that the timing of extreme market movements between REITs and stock indexes is almost perfectly in sync. They concluded the diversification benefits of REITs are sometimes not present when they are needed most."
• "REIT returns exhibited stronger asymmetric correlations than stock, bond or even collateralized mortgage-backed securities over their sample period from 1999 through 2008. Asymmetric volatility was defined as increased return volatility after a negative shock"; low correlation during good times and high correlation during bad times is very bad for you (this is the asymmetry part), and I think they're saying that REIT-stock and REIT-bond correlations suffer from this pattern more than stock-bond correlations
• “existing evidence suggests that REITs can provide portfolio diversification benefits under some market conditions, but not all. There is significant evidence that REITs may be harmful to a mixed-asset portfolio during times of market distress.”
• heavy paraphrase: for stock-bond portfolios and their efficiency (modern portfolio theory), adding REITs pre-2006 didn't help, and adding REITs post-2006 hurt
• "Neither Kizer and Grover nor Stelk, Zhou and Anderson recommend excluding REITs from equity portfolios. Instead, their results should lead investors to conclude that REITs are an equity security with only marginal diversification benefits. Thus, they should not receive a weighting in investor portfolios greater than market-capitalization-based weights. According to data from Morningstar, REITs currently represent approximately 3.7% of the iShares Russell 3000 ETF (IWV) on a market-capitalization basis, which is a valid starting point for a REIT allocation in a diversified portfolio."

Article 2: Avoid Private Real Estate Assets

http://www.etf.com/sections/index-investor-corner/swedroe-avoid-private-real-estate-assets
author: Larry Swedroe

"Private real estate assets" as in private real estate funds, not as in you buying a house to rent out.

• "a question I’m often asked involves the merits of investing in private real estate as an alternative to publicly available REITs (the latter vehicle is our recommendation)"
• "Cambridge Associates’ database allows us to compare the performance of these institutional private real estate funds with the performance of publicly available REITs. For the 25-year period ending 2017, private funds in the database returned 7.6%, while the FTSE NAREIT REIT All Equity Index returned 10.9%. For the privilege of investing with the greatest institutional managers, many of whom are not available to the general public, and in return for sacrificing the daily liquidity available with public REITs, the private, illiquid institutional investments underperformed by 3.3 percentage points a year for 25 years.  As bad as that sounds, the reality was actually far worse. The reason is that the private real estate investments used much higher amounts of leverage."

Article 3: Real Estate Isn't Special

http://www.etf.com/sections/index-investor-corner/swedroe-real-estate-isnt-special?nopaging=1
author: Larry Swedroe
TODO