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Wouldn’t it be great to invest in something that’s safe but can actually grow in all market scenarios?
It would obviously, but those types don’t really exist. That’s why investors usually like to mix their portfolios up and buy a bit of everything—that way, whichever way the markets go, their portfolios are safe.
But what are these investments exactly?
Stocks, REITs, and bonds all come with their own level of risk and reward to take into consideration. However, some assets have a history of outperforming others, which help investors minimize risk while increasing the potential for higher returns.
In this guide we are going to take you through the ins and outs of REITs and stocks, we’ll delve into which is better for short term returns and which is better for long term returns, and how they work in the grand scheme of things.
What you’ll learn
- What are Stocks?
- What are REITs?
- Do REITs Pay Monthly Dividends?
- Is REIT Considered a Stock?
- Differences Between REITs and Stocks?
- Are REITs Riskier than Stocks?
- Why is Real Estate a Necessity?
- Reliance on Dividend vs. Growth
- Which Brings Better Short-Term Results?
- Which Brings Better Long-Term Results?
- Which One is Better?
- Conclusion
What are Stocks? 📗
Stocks are a form of currency. They represent your share of ownership in a company. For example, if a company issues 600 stock shares and you buy 6, you will be the brand new owner of 1% of a company.
Investors buy stocks in the hope that it will increase in value over time. If the company stock they have invested in increases, then it can be sold for a profit.
But companies don’t tend to just issue 600 shares of stocks. Oh no, siree. They tend to issue hundreds of millions, or in some cases billions of shares.
As you can imagine, it’s a lot, and as opposed to the 6 = 1% calculation above, calculating 6 shares out of billions is a whole other story. Now, you own merely a fraction of a percent of the company – not so exciting, ey!
The value of the stock you now own will fluctuate depending on other shareholders, and whether they choose to keep or sell their share. One of the singular, most important aspect of a stock’s price is how much the company is bringing in. This is one factor that helps investor’s decide if they will buy a (tiny) piece of the company.
What are REITs? 📘
A REIT is an acronym for Real Estate Investment Trust. Essentially, these are corporations that have been created by the federal government especially to create vehicles for investment in the housing market.
The Government created these investment vehicles for a myriad of complicated reasons one of which include the tax benefits that come from investment in housing, without which cities would deteriorate with declining tax but increased demands for services. A strong housing market is essentially a sign of a strong economy and one in which investors invest in. But this doesn’t really concern or affect investors, so let’s move on.
What is relevant is that REITs offer investors the opportunity to make an income through commercial real estate ownership i.e. buying apartments or offices to meet the demand of the economy. Just how investors reap the rewards from exposure in a stock, REIT investors earn an income by owning a REIT unit.
Do REITs Pay Monthly Dividends? 🤔
Investing in a REIT is different to investing directly in real estate because a REIT is required to pay out 90% of its income to shareholders, every quarter, as dividend. While it isn’t a monthly payout, it’s still pretty high. In this case, the net income is the amount remaining after all other expenses have been deducted.
Therefore, a REIT makes money by placing a business that makes cash onto land, or renting out land to a business that makes cash. The REIT will then take that money and use it to pay the insurance, property tax, mortgage, and all other payments like maintenance on the property.
After these payments are made, REIT shareholders will get 90% of the rest.
Is REIT Considered a Stock? 🧐
The real estate and stock market trends in recent time have portrayed some significant benefits of investing in REITs shares.
Understanding the difference between a REIT and a stock will help you discover whether it is the best choice for your portfolio.
A REIT is a company that owns, operates, or finances large, profitable real estate properties that bring in a regular income.
The properties in a REIT portfolio might include anything from office buildings, hotels and apartment complexes to healthcare facilities, data centers and infrastructure – in the form of cell towers, energy pipelines, fiber cables- not to mention retail centers, plain old self-storage spaces, warehouses and timberland.
In general, REITs specialize in a particular real estate sector. Though, speciality and diversified REITs can hold numerous types of properties in a portfolio, such as a REIT that’s made up of retail and office properties.
A large portfolio of REITs are publicly traded on major securities exchanges where investors can buy and sell them just like stocks in the financial market. These REITs are usually traded in a significant volume and are known to be highly liquid instruments.
What Are the Differences Between REITs and Stocks? ⚖
While REITs and stocks are both investment types that investors can buy on stock exchanges, they operate differently on the investment market.
As previously mentioned, those who own stocks in a company own a (very) small portion of that company. That company can be any kind of business and, in a general way, the future earnings growth of the company each year will help predict the value of the company, in addition to its long term growth.
Theoretically speaking, and what all investors hope, the company value reflects the continuous increase in its stock over the long term. In some cases, the company also rewards shareholders by paying out a portion of its excess cash as dividends. Bare in mind though, this is not a requirement and totally depends on the generosity (in loose terms) of the company.
Basically, REITs also issue shares for investors to buy partial ownership. Anyone with a share of a REIT will also own a small piece of the REIT. However, unlike stocks, shareholders in a REIT not only own the land the REIT owns, but also any and all earnings generated by the business on the land.
Volatility 📉
In the long term, real estate is known to have appreciated in value. Just as the stock market is volatile, so too is the housing market. But in both markets, the long term value will increase.
One one hand, shareholders of stock cannot be guaranteed dividends, one the other hand, 90% of income from the REIT must be paid as dividends to shareholders by law – pretty sweet.
Real estate tends to slowly change in value in comparison with stocks. So, over the long term this means that stocks could potentially appreciate more than REIT.
That said, REITs are less volatile. Thus, fluctuations may not go as high. Let’s delve a little deeper at exactly what risks you face (or lack thereof when investing in Resits.
After that, we’ll look at which would be your best depending on whether you’re looking to make returns either short term or long term.
Are REITs Riskier than Stocks? ⚠
Ironically, 2020 is the 12th bull market, which began after the financial crisis of 2008-2011 and has already lead us into a pandemic-induced recession.
While 2019 was an overall rewarding year particularly for REIT investors – with a 1,700% return since 1989, investors in 2020 have taken a massive hit.
Of course, such gains were unlikely to continue forever and as they say, and so came a new flow of negative returns for REITs and stocks.
Historically, we have already outpaced the 5 – 10 year recession intervals. Typically, they hit when unemployment rates hit 4 – 5 %. The unemployment rate during the height of the pandemic went over 15% at in April 2020, which should speak for itself.
This means folks, that a recession is on the cards. Interest rates have peaked and the IMF have stated that the “great lockdown” was the worst downturn since the great depression, with a 3% hit to the global economy.
So, what can you do now that a recession might come at some point? Well, one thing you can do right now is move your portfolio more towards more conservative investments.
Businesses Come as Quick as They Go, Real Estate is a Necessity 👨🏫
Businesses come as quickly as they go, well-located properties on the other hand, are here for good (relatively) and as long as there are properties, there will also be landlords making an income off tenants regardless of market conditions.
If you’ve been following the news at all you will have seen how vulnerable businesses are in the face of a crisis. With 10s of millions expected to lose their jobs, the U.S. Government enforced an emergency loan program in an attempt to get money into the hands of small business owners quickly.
But it’s not just small businesses that are at risk. We have seen it time and time again where a highly successful company with a market-leading position would lose it all because of a new innovation that caused their product to become obsolete. Even large companies including Groupon and Tesla had taken huge hits.
In comparison, current well-located properties that are leased to tenants are under no pressure due to the following reasons:
- The property is in a good location and the tech industry is not being impacted as much as other industries
- Landlords have contracts that tenants must abide by until it is up which is after 1 year or more.
- Landlords are the first to be paid. A lack of rent means that a business cannot operate so paying landlords is usually a priority
- If a tenant loses their job or for whatever reason cannot pay rent, the landlord can simply put it up for rent to another/other tenant/s.
- As real estate is in scarce supply and is essential, it will always be valuable
Basically, landlords are part of the wheel that collect returns for businesses without any great risk.
REITs Generate More Resilient Cash Flow 💰
As we discussed briefly above, landlords participate in the cog of profit brought in my tenants by charging rents in a contractual agreement – usually for 1 year or more.
This protects the property owners from volatile conditions and therefore, property earnings generally lag the economy with more stable conditions over the total market cycle. This is especially true for REITs because they own very diverse portfolios with potentially 100s of leases.
REITs Are Traditionally Less Volatile 💸
As REITs offer a more resilient cash flow, they are also usually less volatile than some stocks. A measurement of systematic risk, the Beta, confirms this because the Beta of US REITs has in most time periods been remarkably low. This means that this particular asset class went through less fluctuations than the US Stock Index overall.
In spite of periodically collapsing from increased volatile conditions that exist in the markets over the short term, REITs follow the real estate market in the long run.
In this case, there is a decreased risk of a big loss of earnings because it’s more stable, and a high dividend payment usually protects against the short term market fluctuations that exist in the stock market.
In an interview with NAREIT in 2014, a professor at the University of Denver, Glenn Muller notes that the general volatility of REITs is on average 30% – 40% of the entire stock market, hence making them low-risk investments.
A Reliance on Dividend vs. Growth ⚔
Today, the economy is slowing at a drastic pace which means that it would be a surer choice to generate returns from dividends, as opposed to uncertain capital appreciation.
As we mentioned, REITS pay a higher dividend over stocks because a) Cash flow from properties is consistent and high; and b) Secondly, REITs are required by law to pay out a minimum of 90 % of their taxable income in order to keep a REIT status.
A REIT portfolio has the potential to generate a 7.7 yield on dividend, with a 73% payout ratio. In the long term this will grow through a profitable mixture of dividend per share growth and reinvested dividends which will have a compounding effect.
As so, REIT investors are not reliant on uncertain stock market appreciations to make lucrative returns. As the S&P 500 yields a mere 1.8% stock investors can be more vulnerable to risk of future earnings disappointments and volatility should growth targets fail to be reached.
Which Offers More Margin Safety? 🛡️
The REIT sector suffered a brutal month in February with a -7.58% average total return, but it was even worse for much of the stock market, both of which investors were selling off by the end of the month due to the uncertainty of and continuous worldwide fear of the pandemic.
With back to back declines in the first two months of 2020, The average equity REITs has an overall return of -8.3%. The REIT sector lagged behind the NASDAQ at 6.38%, but outperformed the S&P 500 at -8.41 and the Dow Jones Industrial Average at – 10.07% in February.
This shows that although both sectors are taking a hit, REITs offer greater margin of safety at times of crisis. Investors looking to delve a bit further into the REIT sector could take a look at the big variations in valuations and larger REITs such as small-cap REITs. However, these have also underperformed their peers for a third month in a row, leaving much uncertainty.
Top REITs in a Late Cycle Economy 🥇
With that, not all REITs are the same and we must be very highly selective about which we choose to avoid the potential for great losses, but this has never been more true today as we potentially approach a recession.
During a recession, almost all equity sectors drop in value, and we are already seeing the first signs of this as we outlined above, but the difference in magnitude can be enormous. Some sectors get demolished while others suffer a limited amount through the entire phase.
For example, at the beginning of the financial crisis in 2008 REITs dropped 60%. This same year healthcare REITs fell only 12% because this cash flow was significantly more resilient to times of crisis.
Taking some eggs out of your hotel REITs basket pre 2008 and reinvesting them into healthcare REITs would have immensely reduced the losses that were to come, but humans are emotional creators and the fear of missing out on gains in the hotel sector unfortunately resulted in some major emotional decision making.
Characteristics of the Best REITs 📊
REITs could drive outperformance in the next recession with the following characteristics:
- ☑️ Building with long term lease contracts and automatic rent increases.
- ☑️ A focus on deleveraging or a conservative balance sheet.
- ☑️ Conservative balance sheet and/or a focus on deleveraging.
- ☑️ Defensive properties including self-storage, net lease, healthcare, storage and residential. Each of these are so resilient in their own right that they actually increased dividends during the last financial crisis. Such sectors include W.P Carey (WPC), Realty Income (O), Public Storage (PSA), and Venta (VTR).
There’s one significant factor that could change all of this though, and that is whether you are looking to make a short-term or long-term investment. In this case, it’s all up for play.
Which is Likely to Bring Better Returns Short Term? 📈
First, you’re probably wondering what exactly a short-term investment is.
Investors choosing to make a short term investment usually do so because they need money at a certain time. For example, if you need money for a mortgage, or the arrival of a child, or maybe you’re getting married, then you will want money at that time.
In short, short-term investments are made for 3 years or less. Because you’ll usually be aiming for higher returns, there will also be an increased risk attached. Stocks have the potential for increased returns in the short term, as well as increased loss.
This means that in order to invest cash properly without squandering it on a poor investment you’ll want to consider safety first and foremost.
A stock broker or financial planner can help you navigate your way through the stock market based on the level of risk you’re willing to take in addition to your experience, goals, and needs.
🔎 Narrow down your search: Check out our list of the best stock brokers.
Which is Likely to Bring Better Returns in the Long-Term? 💲
While stocks traditionally have the highest potential for reward over time, they’re also the riskiest, and as stock markets plummet around the world, we can see that high risk investments aren’t necessarily the best way to get higher returns. So for long term investments, REITs win.
Overall, real-estate investments have outperformed stocks by more than 1 percent each year on average, since 1960, as highlighted by a recent study conducted by researchers in the Netherlands. In the 2019 study, Historical Returns of the Market Portfolio, that looked at financial assets in the modern era and their performance worldwide, from 1960 to 2017.
Throughout this time, real estate investments beat inflation by an average of 6.43% each year. This is compared with global stocks performance of 5.45% a year. Real estate outperformed stocks throughout recessions and economic expansions, and most notably, throughout periods of rising and falling inflation, the study found.
While real state did show more varying returns over stock market returns, it would be hard to conclude that it’s a riskier asset, given the data. Furthermore, while REITs were affected during these periods they were not affected nearly as much as stocks.
With that, it’s best year was even better than stocks, and throughout the entire cycle, it had fewer serious downturns than the stock market ie. years where more than 10% was lost.
Side note: When researchers looked at two other major asset classes, non-government bonds earned 3.5% per year, while government bonds earned 3.06%.
Consistency 🎛
In terms of consistency, REITs have performed outstandingly, too. Starting from the 1960s up to 2015 they have undergone only one (1) really bad decade: The 1990s, when returns rose just above 0.
Apart from this, the real-estate sector brought in strong returns every decade reaching around 6 – 7%, the study noted. By contrast, stocks globally plummeted to the zeroes in the 1970s, losing ground between 2001 up to 2010.
From this research, there are 3 important factors to consider. First, the study looking at global assets, not just those of you in the U.S, but investors around the world should capitalize on its findings by investing in REITs.
Secondly, the study looked closely at listed commercial real estate. This is not the same as private residential estate.
In countries like the U.K and the U.S, most residential homes are owned by those living in them. Lastly, any and all research should work to guide our decision but not determine them.
Nonetheless, adding more REITs to our portfolio is looking like a good option.
Which One is Better Today? 🏆
The volatility of the stock market drastically increased in the last week of February, and with so much fear and uncertainty, things will probably stay that way for the foreseeable.
The 2020 U.S. election was just another factor that spurred the uncertainty in the market. The dramatic effects of the coronavirus throughout the world have only added to this uncertainty, given that no one knows what the true effects of it will be, or how long it will be around for.
As a result, expert estimations of the length it will be around for and the magnitude of the economic impact are not coherent and vary greatly.
Uncertainty and heightened fear can lead to unpredictable movements in share prices, which leaves opportunity for investors to switch up their portfolios to profit from assets that are misvalued.
Let’s finish by discussing how much you’ll need to invest in REITs.
How Much Do You Need to Invest in REITs? 💴
Private REITs are not on the exchange or registered with the US, and because of this they are not required to disclose the same amount of information to investors as a public company would. Private REITs tend to have an investment minimum of typically around $1,000 to $25,000, according to NAREIT.
Publicly traded REITs are one of the cheapest and simplest ways of adding real-estate to your portfolio, and are listed on major stock exchanges, like any other sock. Investors can invest in a REIT mutual fund or exchange-traded fund (ETF). And right now, about 87 million Americans are already investing in REITs.
How is the Value of REIT Shares Typically Assessed? 💶
Just like other companies with publicly traded stocks, REITs shares are valued by the market. To help you assess the true value of REIT shares, you should consider:
- ☑️ Projected increase in earnings per share;
- ☑️ Payout ratios of the dividend as a percentage of the REIT FFO;
- ☑️ Management decisions and overall structure of the company;
- ☑️ Projected total returns;
- ☑️ Current dividend yields in comparison with other yield-based investments such as bonds and utility stocks;
The right broker, or financial advisor can help you outline your financial goals and figure out which REITs would be best for your portfolio.
Conclusion 🏁
As a whole, REITs have consistently and repeatedly outperformed stocks and brought in better returns. REITs are less volatile, they bring in a more stable cash flow, and provide a high dividend.
In today’s financial climate we believe that investing in REITs is the smarter and safer option over most stocks. Many investors are most certainly already taking a defensive position in terms of cash flow and dividends
That said, although REITs are typically considered as a defensive asset, in this environment, this is shown to be only partially accurate, and should a further downturn in equities take place, REITs may not act as a hiding place.
Furthermore, remember that all REITs are not created equal and must be selected with care to avoid loss and take advantage of their possibilities.
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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.
About the author
Tim Fries
Tim Fries is the cofounder of The Tokenist. He has a B. Sc. in Mechanical Engineering from the University of Michigan, and an MBA from the University of Chicago Booth School of Business. Tim served as a Senior Associate on the investment team at RW Baird's US Private Equity division, and is also the co-founder of Protective Technologies Capital, an investment firm specializing in sensing, protection and control solutions.
