REITs: Risks and Returns

July 25, 2007


In response to an earlier post on iShares CDN REIT Sector Index Fund (XRE), some readers were interested in the historical risk and return characteristics of REITs. David Swensen writes in Unconventional Success that real estate is riskier and more rewarding than bonds and has less risk and lower returns than equities:

Shorter-term data on market returns confirm the notion that real estate sits between stocks and bonds in risk and return characteristics. Returns covering the quarter century from 1978 to 2003 for an index of marketable real estate securities stand at 12.0 percent per annum, poised between the 13.5 percent per annum return for the S&P 500 and the 8.7 percent per annum return for intermediate-term U.S. Treasury bonds.

Publicly traded REITs have an interesting attribute: they trade at prices that are sometimes significantly different from fair value:

At one point in 1990, by Green Street’s estimate, real estate securities traded at more than a 36 percent discount to fair value. By 1993, the stock market reversed itself, valuing real-estate-related holdings at a 28 percent premium to fair value. The yin and yang continued. In late 1994, the discount reached nine percent, while in 1997, stock market investors paid more than a 33 percent premium to fair value. In the late 1990s, a poor market for real estate securities (that coincided with a wonderful market for most other securities) brought valuations to a deficit of more than 20 percent, a level reached in early 2000. As the non-real estate portion of the market entered bear territory, real estate securities took on bull characteristics, leading to a greater than 22 percent premium to fair value in early 2004.

Though the data used in the book is based on U.S. based REITs, there is no reason to think that the market is very different in Canada. It would be interesting to find out fair value data for Canadian REITs to initiate or add to REIT positions when they are trading at a discount to fair value. Do you know where we can obtain such data?

A Tour of ETFs: iShares CDN REIT Sector Index Fund

July 11, 2007


A Real Estate Investment Trust or REIT is an asset class that allows you to get exposure to real estate in your portfolio. Real estate is an interesting asset class because historically it has offered a higher return than bonds (but less than equities) albeit at a higher risk (again less risk than equities). Also, real estate has low correlation with other asset classes and adding it to your portfolio will reduce overall volatility. An allocation of 5%-10% to REITs seems reasonable but some recommend going as high as 20%.

The iShares CDN REIT Index Fund (TSX: XRE) is composed of REITs that are listed on the TSX. The MER on the fund at 0.55% is on the high side and might be acceptable for smaller investments. However, if you have a large portfolio you may want to invest in the underlying REITs directly because the two largest REITs – RioCan (REI.UN) and H&R (HR.UN) – make up 36% of the fund.

PS: I noticed that Million Dollar Journey has published a primer on REITs, which you may want to check out as well.

The Role of REITs in a Portfolio

December 21, 2005


I received the following query by email and I thought I would expand my reply into a post:

Quick question on your asset allocation. Most of it makes sense – Bonds, US/Canadian/International Equities. But why the REIT as a major asset class?

Real estate tends to have a low correlation with other asset classes, so its inclusion reduces the overall volatility of a portfolio. Also, Burton Malkiel notes in The Random Walk Down Wall Street that REITs have produced comparable rates of return to common stocks over the 25-year period from the 1970s through the mid-1990s. REITs also tend to provide an attractive yield (that at least keeps pace with inflation) and are highly liquid. REITs are also well-diversified asset class and own shopping malls, apartments, hotels, retirement residences, office buildings etc. Note that the passive investment portfolio recommended by David Swensen has a 20% weighting in REITs.

However, I do think that REITs are currently overvalued. The iUnits S&P TSX Capped REIT Index Fund (XRE) is currently yielding 5.63% compared to the 4.5% yield of the 10-year bond. The spread is well below historical averages.