Q. Real estate investments, given high interest rates, make me think twice. Should you have real estate or REITs in your portfolio now, or are there other asset classes that are a better bet?
— Investor
A. We’re glad you’re considering some alternative investments.
We’re a big fan of diversification, so we want to make sure whatever decision you make is looked at with the whole of your portfolio.
Let’s talk real estate investing.
The manager of a Real Estate Investment Trust (REIT) raises money from several investors and uses the pooled funds to purchase — and manage — several real estate properties, said Deva Panambur, a fee-only planner with Sarsi, LLC in West New York.
He said some REITs purchase mortgages of real estate properties.
“REITs offer investors diversification and access to professional management,” he said. “Achieving similar diversification by yourself may not be feasible considering the amount of funds you would need.”
You can find REITs that are offered privately or in publicly-traded formats.
Private ones are less transparent and require extensive due diligence to evaluate, he said.
Let’s look more closely at publicly-traded REITs, which also need to be researched but are more transparent.
REITs are required to distribute a majority — at least 90% — of their income every year so that only the investor pays taxes on those distributions, Panambur said.
“Distributions could be taxed as ordinary income, capital gains or return of capital, each at a different rate,” he said. “REITs are required to provide investors with information on how to allocate distributions for tax purposes.”
Historically, most of the total return of REITs has come from income — similar to bonds — although they trade like stocks with relatively high volatility, he said.
“Since income is such a big part of returns, the market value of REITs fluctuates with the level of interest rates,” he said. “When interest rates rise, as they have since 2022, REITs tend to perform poorly.”
But, he said, making investment decisions based on predicting interest rates is not a reliable strategy and selling an investment after the fact could lead to poor long-term performance.
Your decision to invest in REITs should be based on factors like your need for income, your risk tolerance — because REITs have equity-like volatility — and your desire to gain real estate exposure in addition to your primary home, Panambur said.
Depending on your situation, alternatives to REITs could be other income producing investments such as bonds, dividend paying stocks or preferred stocks, he said, noting that each has its own advantages and disadvantages that need to be considered before including them in your portfolio.
“For instance, bonds are more stable but have provided lower total returns than REITs while dividend paying stocks generally have provided capital gains but lower income than REITs,” he said.