Nearly every retirement portfolio should contain real estate, but most investors can’t buy a building. Fortunately, it’s easy to own property without ever fixing a toilet, or worrying about a roof caving in during a storm.
But first, it’s important to understand real estate as an asset class and its contribution to a portfolio. A property that is well located and leased gives you debt-like cash flow with the opportunity for appreciation like stocks. Leased buildings are valued based upon the stability of cash flow from rents and the cost to replace the building.
Real estate also protects you against inflation, as its value tends to move closely with the costs required to replace it. Think land, bricks, concrete, steel, labor, and fixtures. These costs rise with inflation, and landlords raise rents over time as inflation grows.
Why REITs make sense
You can get a well-diversified real estate portfolio by owning real estate in the form of real estate investment trusts (REITs). These are unique public securities because they pay no taxes and pass through 90% of their income to investors in dividends. From 1970-2009, public REITs returned an average of 9.1% per year. That means money invested in REITs doubled every eight years.
That doesn’t mean real estate won’t have ups and downs. The fair value of the real estate held in the REIT compared to the stock price can easily range between a 20% discount to a 20% premium. Between 2000 and 2009 REITs have been up or down by more than 35%. But while the stocks may swing, you can sleep at night knowing that you own hard, rent-paying assets.
Indexing purists claim that REITs are included in broad-market index funds and if you add REITs to your portfolio, you are guilty of playing sectors. But because so much real estate is still privately held, the economic activity related to the real estate asset class is not adequately reflected in the publicly traded REITs. To truly index global real estate activity requires “boosting” your real-estate holdings by adding REITs.
The best way to own REITs is through an exchange traded fund. The costs are low and you’d be hard-pressed to find an active fund manager with the expertise to consistently pick REITs over many years that will beat a REIT index. In fact, owning REITs through a mutual fund can cost you almost 50% of the yearly dividend you receive, in manager fees.
Instead of paying high fees, buy an ETF that holds all of the REITs that matter. We recommend two SPDR Dow Jones ETFs for REIT exposure: SPDR Dow Jones REIT (US:RWR) , which indexes U.S. real estate, and the SPDR Dow Jones International Real Estate ETF (US:RWX) , which indexes international real estate.
For an annual fee of just 0.2%, RWR gives you the largest 81 REITs in the U.S., including the largest American malls through Simon Property Group Inc. (US:SPG) , self-storage units at Public Storage (US:PSA) , apartments, office buildings, and strip centers. Last year, investors received dividends of 2.9%.
For a fee of 0.59%, RWX allows you to own a piece of companies including Westfield Group(US:WFGPY) with shopping centers worldwide, and apartments and hotels held outside of the United States by Mitsui Fudosan Co. Ltd. (US:MTSFF). Last year, investors received dividends of 3.8%.