Should I invest in a REIT or REIT fund?

Should I invest in either a REIT or REIT fund? Lots of people will give you lots of reasons why you should, but I’m going to give you 9 reasons why you shouldn’t.

9 Reasons why you shouldn’t invest in REITs

1. REITs aren’t a better inflation hedge than stocks
2. REITs and REIT funds have higher fees than the broader market
3. Investment returns are no better than stocks (if not worse)
4. Your net worth is based on all your assets including the house you live in (You don’t need any more real estate exposure)
5. You have all the REIT exposure you are ever going to need through a broad based stock fund (all the real estate companies are in the broad based indices)
6. Income or dividends aren’t worth chasing (in fact many should avoid them)
7. REITs aren’t really real estate
8. If you invest in REITs you are making an active bet that they are going to out perform stocks
9. Adding REITs to your portfolio adds complexity that you don’t need

And its worth unpacking each of those in a bit more detail.

REITs aren’t a better inflation hedge than stocks

Let’s get the biggest elephant out of the room right off the bat.

The most convincing argument I’ve ever heard for having REITs in my portfolio is that it’s an inflation hedge. And whilst I’m inclined to agree to a certain extent, if you look at the data, its hard to find any evidence that stocks aren’t equally good.

In fact, the argument for stocks is stronger because the data we have to work with goes back further. In the scheme of things REITs are a relatively new product.

Of course, when you mention that to REIT lovers, they like point out the fact that REITs will do better in times of hyper inflation.

And there are two problems with that as far as I can see. First, as just mentioned, the data isn’t there to support that argument. Instead they are likely to be basing their argument on real property which as we’ll cover later is a different beast altogether.

Second, we do have data for how stocks behave during periods of hyperinflation in 1920s Germany and unless I’m missing something stocks didn’t do bad at all. (you might like to have a read of this out if you don’t believe me).

REITs and REIT funds have higher fees

There’s a nice quote often attributed to Einstein that goes something like this:

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.

Einstein

Which is the whole reason we invest in the first place, but John C.Bogle, the late founder of Vanguard and originator of the first index fund liked to build on these words of wisdom with a quote of his own:

What happens in the fund business is that the magic of compounding returns is overwhelmed by the tyranny of compounding costs.

The key being, though we can’t control the performance of our investments, we certainly can control the fees we pay. And that matters.

Investment performance is your returns minus fees. Average actively managed fund costs in the UK are about 1%.

Now, that doesn’t sound like a lot but seeing as though the best data out there (Triumph of the Optimists: 101 Years of Global Investment Returns – best read in the library) suggests returns of around 4% over inflation in the future, that’s a quarter of your return gone in the blink of an eye. And by the way REITs and REIT funds usually charge more.

And even if you take the sensible approach and opt for low cost index funds or ETFs you’ll still see a big difference.

iShares are usually one of the cheapest providers of ETFs in the UK. Their Core FTSE 100 UCITS ETF containing the UKs biggest stocks has ongoing charges of 0.07% compared to 0.40% for iShares UK Property UCITS ETF. That’s nearly six times as expensive!

And by the way its not like the FTSE100 doesn’t contain any real esate companies or house builders. The following list are all in the FTSE100.

• Barratt Developments
• Berkeley Group Holdings plc
• British Land
• Ferguson plc
• Land Securities
• Persimmon plc
• Segro plc
• Taylor Wimpey

And that doesn’t include all the other companies that are directly linked to real esate like hotels and banking for example

Investment returns are no better than stocks

If I got a £1 every time I heard somebody say REITs have better returns than stocks I’d be a millionaire by now.

And the thing is that’s absolutely not the case. It was the case for a period of time in the US (where everybody’ bases their assumptions). But that was then and this is now. Check out the chart below.

Red is US stocks (S&P 500) and blue is US REITs. We start in 1994 because that’s when the REIT data kicks off. As you can see there was some outperformance by stocks around 2000 but other than that they have performed pretty much the same.

Not only that, but if REITs had being going as long as stocks and we compared the returns over a longer time period in all likelihood stocks would out perform. US housing has barely beaten inflation over the long term (Triumph of the Optimists: 101 Years of Global Investment Returns).

Your net worth is based on all your assets including the house you live in

If you are a billionaire or perhaps even a multimillionaire you may have more of your wealth in other assets. However, if you are not and you own property, in all likelihood most of your wealth is tied up in that.

If you live in your own property include that in your portfolio and see if you need any more exposure to property.

Nine times out of ten you are going to be far too over exposed to real estate already.

But what about if you don’t own your own property.

You have all the real estate exposure you are ever going to need through a broad based stock fund

If you look under the hood of any of the main indices you’ll find they include all the real estate companies anyway.

The FTSE100 is jam packed full of property companies. Looking at an alphabetical list you only need to go as far as B to find Barratt Developments, Berkely Group Holdings and British Land.

With the S&P 500 you’ll get there even quicker. Alexandria Real Estate Equities, Apartment Investment & Management, and Avalon Bay Communities, Inc appear in the As.

And that’s only the beginning. There aren’t many businesses that don’t have some exposure to real estate. Think offices, warehouses and the like.

Though the working at home phenomenon could impact this in the future, there aren’t many companies that don’t at least rent their premises if not own them outright right now.

Income or dividends aren’t worth chasing

Another big incentive for owning REITs is the fact they provide income in the form of dividends. Sounds great but so do stocks.

Again comparing UK stocks (iShares Core FTSE 100 UCITS ETF) to UK REITs (iShares UK Property UCITS ETF) today you find dividend yields of 3.4% and 2.6% respectively. In other words, in this case stocks beat REITs hands down.

Not only that, but in many cases you are better selling your shares rather than taking dividends for tax purposes. (You can read more about why Dividends might not be the answer here).

REITs aren’t really real estate

You might be thinking we’re anti-real estate investing here. But let’s be clear. That’s not the case at all. The right house bought in the right area usually beats inflation.

Even better returns can be had with a mortgage and you might even beat stocks with mortgaged rental properties. You just have to appreciate there will be work to be done and risks involved. Some people love it. Some people hate it.

The problem with REITs is that they take that mortgaged rental property idea and put bells on it.

Real estate begins with a piece of land. I have no doubt that privately owned land behaves differently to stocks. Building a house on that land changes the game. But if you live in it, again, I have no doubt it will behave differently to stocks.

A single rental property is a small business. You could deal with that yourself and let’s face it you’d need a lot of them to make it into a big business. And even then in private hands its going to behave differently to stocks.

Of course house prices do fluctuate from time to time, but for the most part, most of us aren’t aware of this going on in the back ground.

Even the mega crash in 2008 only knocked an average of about 20% off UK property. Individual stock prices (or REITs) can do more than that in a day.

Funds are a bit safer but even those aren’t immune. Take iShares UK Property ETF again. It lost over 60% in 2008.

If you can invest in a REIT i.e. because its public and floated on the stock market, it will be massive. Massive REITs are just massive businesses like any other. When you buy shares in them, you are buying stocks. It’s really that simple.

You are making an active bet that they are going to out perform stocks

If you invest in an individual REIT or fund you are essentially making an active bet that you will beat the wider market.

Unless, you are a seasoned pro that is unlikely to be the case and in fact even if you are a seasoned pro the chances are slim. You might want to take a trip over to S&P Global and have a look at their SPIVA research if you don’t believe me.

In short, if you invest in REITs you are gambling. And that’s not usually a good way to grow your wealth.

Adding this kind of investment to your portfolio adds complexity that you don’t need

Nowhere has that classic US navy method KISS, or Keep It Simple Stupid proved more useful than in investing. Time and again, evidence shows the simpler your portfolio the more successful you are likely to be.

Vanguard have shown how investors in their all-in-one index funds out perform just about everyone else. Essentially, because you don’t need to think or make any decisions. You just add money and Vanguard do the rest. The less tinkering you do, the more successful you are likely to be.

The best example of this is a study completed by Fidelity that found the portfolios with the best returns belonged to the already deceased and those that had forgotten about their portfolios.

These days you can put together a strong investment portfolio with just a couple of funds.

If REITs were guaranteed to outperform stocks or they were cheaper, then maybe there would be an argument for adding them to your portfolio. However, as discussed already, neither of these is true.

Should I invest in a REIT or REIT fund? – The bottom line

So just to be clear. I’m not saying real estate isn’t a good investment because it absoutely can be. Furthermore, I’m not even saying REITs can’t provide good investment returns. They certainly can.

I’m just saying, there’s no need to add them to your porfolio. You add cost, complexity and risk when in all likihood you already have all the real estate exposure you are ever going to need.

So for most people most of the time you shouldn’t invest in REITs period.

You are better off sticking with broad based stock fund because that will contain all the real estate exposure you are ever going to need.