How to Protect Portfolios With REITs

NAREIT study using Morningstar analysis shows that a 14-20% REIT allocation can both protect wealth and boost returns

According to a recent Morningstar analysis, investors can protect their assets and improve their long-term returns by holding REITs, the industry group NAREIT said Monday. The research, which took into account the frequency of extreme market downturns, used the latest portfolio-optimization techniques.

Based on historical capital-market assumptions for 1990-2009, the optimization produced portfolios with allocations from 14% to 20% of a global investment portfolio in REITs for investors with low to moderate risk tolerance. Such portfolios were found to improve annualized long-term total returns by 60 basis points for a risk-averse investor portfolio (from 7.6% to 8.2%) and by 30 basis points for the moderate-risk investor portfolio (from 9.4% to 9.7%) without taking on more risk.

Steven A. Wechsler“Many investors limit their portfolio allocations to stocks, bonds and cash because they are unaware of the potential diversification benefit of real estate,” said Steven A. Wechsler (left), president and CEO of NAREIT, in a statement. “We believe the Morningstar analysis supports the case for risk-averse and moderate-risk investors to diversify their investments using publicly traded REITs, in part because of the dividend income cushion that REITs provide as a component of their long-term total returns.”

For the NAREIT-sponsored study, Morningstar also performed another optimization that placed greater emphasis on downside risk. For investors with a low-to-moderate risk tolerance, this optimization produced portfolios that allocated 14% to 20% of a global investment portfolio to publicly traded equity REITs. According to NAREIT, dividends from REITs – which must distribute at least 90% of taxable income to shareholders in the form of dividends – may account for the high allocations.

Roughly 56% of the total return from U.S. equity REITs from 1990 to 2010 came from dividends, compared with only 23% of the total return from companies in the S&P 500 Index, according to index data.

For this 10-year period, the compound annual total return for large cap-stocks as measured by the S&P 500 was 1.41%. REIT investors earned an average annual total return of 10.33%, and 61.2% of this gain from the consistent REIT dividend.

The report acknowledges that it may seem counterintuitive, given the volatility of real estate during the financial crisis, to consider REITs as so important. “However, the high and steady dividends distributed by REITs year-in and year-out play a large role in the total return of REITs,” the study explains.

NAREIT’s report, “The Role of Real Estate in Weathering the Storm,” is available on the Web. And NAREIT's Real Estate Portfolio Optimizer can be found online, as well.

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