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Real Estate Investment Trusts can outperform in 2019 – Sarasota Herald-Tribune

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For the last 18 years, I’ve suggested investors should carefully consider the desirability of adding exchange-traded equity Real Estate Investment Trusts (REITs) to their portfolios. For 2018, I said, “Since non-REIT EPS growth will continue strong in 2018 and REITs will be under pressure from rising interest rates, my forecast is that despite their dividends and “reasonable” prices they will struggle to deliver low to middle single-digit total returns and likely trail the S&P 500.” This forecast was off. REITs total returns, as given by the “NAREIT All Equity REIT Index,” lead the S&P 500’s by 0.4 percentage points. Unfortunately, they both had negative total returns. However, the annualized total return for REITs for the 36 years since 1972 was 11.5 percent versus 10.2 percent for the S&P 500.

What’s unique about REITs?

They are regulated companies like mutual funds, but for real estate. A REIT must distribute at least 90 percent of its net earnings annually. In return for this, REIT earnings are taxed only once — when they are paid to the investor as dividends. Often only part of the dividend is taxed, and it may be taxed at less than the investor’s full nominal tax rate because of the new tax law.

Some REITs specialize in owning and leasing one kind of property — for example, shopping malls — and are known as equity REITs. Others deal in loans and are called mortgage REITs. We only consider equity REITs as mortgage REITs and their dividends are too volatile.

Exchange-traded REITs provide the benefits of cash flow from real estate leases with the liquidity of a stock. Since REITs’ earnings tend to grow with inflation, REITs may offer an inflation-hedge.

Since REITs are required by law to distribute almost all their earnings to stockholders, to finance their capital requirements they must either borrow money or sell new stock. Thus, many REITs tend to be highly leveraged with significant interest costs. These can cause problems if money is “tight” and they have maturing debt. This isn’t true today.

REITs’ prospects for 2019?

Investors often purchase REITs for their dividends, as they are higher than high-quality bond interest rates. Currently, it looks like interest-rates may have stabilized. Thus, the difference between the two may not narrow, increasing REITs desirability. Currently, the average REIT’s dividend is about double the S&P 500’s and 50 percent higher than the 10-year Treasury note.

REITs’ operating fundamentals are sound, and REITS have been out of favor for several years. With the high volatility of the market, investors will return to looking for securities like REITs to supply safe dividends and perhaps lower overall portfolio volatility because of their relatively low correlation to the broad market. My forecast is that REITs will outperform the S&P 500 in 2019.

Additionally, per a Morningstar study, over a 40-year period, a diversified portfolio with a 20 percent allocation to equity REITs reduced portfolio volatility and provided an annualized total return of about half a percentage point higher than a portfolio with no equity REITs.

 Send comments and questions to Robert Stepleman, Dow Wealth Management, 8205 Nature’s Way, Lakewood Ranch, FL 34202, or rsstepl@tampabay.rr.com. Follow him on Twitter @logicalinvestor. Stepleman is associated with Dow Wealth Management LLC as a lecturer and chief portfolio strategist. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser. Past performance is not indicative of future results. The data and performance information is for informational purposes only and is not intended as a solicitation.

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