Are Real Estate Investment Trusts (REITs) Helping Your Portfolio?
Real Estate Investment Trusts or REITS trade just like stocks. They are companies that own, operate, or finance income-generating real estate. They must pay out 90% or more of their taxable income in the form of dividends. REIT classification helps the entities avoid the double taxation of being a public corporation. Investor pay the same tax rate on dividends as those they receive from stocks. If you own an S&P 500 Index fund you own REITs. They were added to the benchmark in 2016. Today, there are 29 REITs in the S&P 500 that comprise 3% of the index.
When most people hear real estate, they think: homes, office buildings, and strip malls. And that is certainly a big part of the REIT universe. But, there is also a large and important cohort of non-traditional REITs: cell phone towers, data centers, storage centers, etc. In fact, these alternative parts of real estate have been the best performers. Over the past 15 years real estate public equities as an asset class underperformed the S&P 500 over every time period.
The Mendoza line1 of the universe is multi family apartment REITS which performed exactly in line with the benchmark.
The real star out-performers of the group were all non-traditional REITs. Cell towers as a group returned 16%, data centers 15%, and storage centers earned 15%.
Another out-performing category that flies a bit under the radar is manufactured housing communities (MHC). None of the MHC REITs are yet part of the S&P 500, but they are approaching the size to be added. Equity LifeStyle Properties (ELS) is one of the three public traded MHC REITs. ELS operates a low-key strategy that outperformed the S&P 500 by 6% a year with half the risk.
ELS was founded by Sam Zell. Since IPO on February 25, 1993, Equity LifeStyle returned 16.7% per year compared to the S&P 500’s 10.5%. Even more impressively, ELS generated this performance with a beta of 0.52. While the S&P posted five negative years since 1993, ELS had only 3. Further, the drawdowns for ELS were shallower. While the S&P 500 fell by -37% in 2008, ELS returned -12% that year. Even compounding 2007 and 2008 for ELS yields a cumulative negative return of -26%, much less odious than the market’s -37% 2008. ELS IPO’d for about a split adjusted $1. Today, they are priced at $78. Further, they paid a cumulative $16 in dividends. Financial theory says you have to accept greater risk to generate greater returns. ELS appears an exception, can they keep it up?
We will attempt to answer the question in a future blog post.
[1] The Mendoza Line is an expression in baseball deriving from the name of shortstop Mario Mendoza, whose low batting average is taken to define the threshold of incompetent hitting. The cutoff point is most often said to be .200[1] (Mendoza's career average was slightly better than that, at .215, but he also hit under .200 in over half of years in the MLB)[2] and, when a position player's batting average falls below that level, the player is said to be "below the Mendoza Line". This is often thought of as the offensive threshold below which a player's presence on a Major League Baseball team cannot be justified, regardless of his defensive abilities. The term does not apply to pitchers, who are not expected to be effective hitters.
[2] Beta measures the risk or volatility of a company’s share price in comparison to the market as a whole. For example, a company with a beta of 1.1 will theoretically see its stock price increase by 1.1% for every 1% increase in the market. Put differently, if you’re expecting the overall market to return 8%, a stock with a beta of 1.5 should return 12%. Definition courtesy of finbox.