Call #1: Maintain Neutral REITs
As investors relentlessly search for income, I continue to get questions about the role of REITs in a portfolio. While I believe that REITs are a reasonable alternative for investors looking for extra yield, I’m sticking with my neutral view of the sector for a few reasons.
First, a broad index of U.S. REITs is currently trading in line with its historic value versus both the broader market and the U.S. Financial Sector.
Second, and probably more important for yield-hungry investors, the current spread between the yield on a broad REIT portfolio and the yield on the U.S. 10-year Treasury suggests that while REITs are reasonably priced, they aren’t particularly cheap. In fact, the incremental yield over the 10-year Treasury that REIT investors are generating for taking incremental risk is close to the long-term average.
Today, investors are getting around 3% on a broad REIT portfolio, versus the roughly 2% they are getting for the U.S. 10-year Treasury note. In other words, the spread between the yields is roughly 80 basis points, in line with the spread’s 10-year average. (Historically, partly because of the additional compensation investors demand to hold a riskier asset, REITs have typically yielded roughly 80 basis points more than the 10-year Treasury note.)
Finally, though the U.S. housing market is showing signs of stabilizing, I don’t believe this means that investors should aggressively buy REITs. Why? Though the housing market is stabilizing, it’s happening slowly, and the recovery is likely to be a long process. After the bursting of a credit bubble, housing markets typically take up to a decade to come back.
In short, while I don’t think investors need to worry about products that have REIT exposure embedded in them, I would maintain a benchmark exposure to the sector rather than an overweight one.
In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. REIT investments are subject to changes in economic conditions, credit risk and interest rate fluctuations.