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Owning REIT Shares Can Help Minimize Risk

Diversification has been touted as the best way to avoid the steep ups and downs that can hit investors who rely too much on a narrow range of investment types.  But the financial crisis of 2008-2009 ripped a huge hole in the diversification safety net, as most assets plunged together.

In the wake of the crisis, many investors are understandably concerned about the right mix of assets—stocks, bonds, real estate, cash, and other investments.  For most people, it’s not just a question of maximizing returns, but also of minimizing risk.

Investing in real estate through real estate investment trusts (REITs) can be part of the answer, especially when it comes to reducing volatility and risk, according to a new study commissioned by the National Association of Real Estate Investment Trusts (NAREIT).

“Diversifying the global portfolio to include real estate stocks alongside other stocks and bonds can potentially increase risk-adjusted returns and minimize expected losses for both risk-averse and moderate-risk investors,” concludes the study based on 20 years of data from Morningstar Inc.

“The Role of Real Estate in Weathering the Storm” suggests that placing 14% to 20% of a global investment portfolio in real estate equities benefits those with low to moderate risk tolerance, especially when extreme risks such as a broad financial collapse are factored in.

Even including the real estate crash that started in 2006, REITs returned 10.63% from 2000 to 2009, compared with a negative 0.95% for the Standard & Poor’s 500 stock index.  That’s partly due to the special tax status of REITs that forces the investments to return 90% of income as taxable dividends.  Those dividends accounted for 56% of REIT total returns, compared with the 23% that dividends contributed to the returns of S&P 500 companies (between 1989 and 2012).

Many wealthy investors are on board.  According to Spectrem, one third of investors with a net worth between $5 million and $25 million own REIT shares, and two-thirds of those with $15 million to $25 million own REITs.  The average REIT stake of those investors is valued at $1.2 million.

A REIT is a company that owns and manages income-producing real estate.  Most invest in specific types of property, such as offices, apartments, shopping centers, malls, industrial facilities, hotels, self-storage facilities, health-care properties, and more specialized properties.

According to Morningstar, REITs offer the potential for high yields, simplified tax issues, liquidity, and diversification.  Drawbacks include a tendency for shares to lose value when demand rises for other high-yield assets such as U.S. Treasury bonds, and the potential for high property tax costs.

We can help you determine what portion of your portfolio to invest in REITs and what types of REITs best suit your financial goals.

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