A real estate investment trust, or REIT, is a real estate company that enjoys special tax treatment by virtue of its legal structure. By law, the REIT must pay out at least 90 percent of its taxable income in order to avoid paying corporate taxes. CLS uses REITs in our Master Manager Strategy and ETF Strategy, but most heavily in our ETF Managed Income Strategy for their yield.
Using REITs can provide:
- A good alternative for investors seeking income
- A hedge against inflation
- Diversification to a portfolio
- More liquidity than private real estate
- Dividend growth by increasing rent and acquiring properties
- Access to public markets, making it easier to raise money and resulting in liquidity and expansion
Valuation of REITs:
REITs are valued on their ability to pay current income as well as the potential to increase dividends over time. For that reason, the most common ratios used in valuation compare price (P) to some form of cash flow number, typically Funds From Operations (FFO). A high P/FFO ratio, or low dividend yield, implies that investors expect growth and/or current bond yields are low. Increasing yields on U.S. Treasuries would likely put downward pressure on REITs. However, these yields would likely only increase in response to excess inflation and REITs can take advantage of inflation by increasing rents, leading to higher dividends.
CLS’s current REIT allocation:
CLS has sold mid-cap equities to buy REITs, as the risk associated with REITs has declined sufficiently to justify the tradeoff. It is worth noting that since 1970, real estate has outperformed several major asset classes, including large U.S. equity, small U.S. equity, non-U.S. equity, U.S. bonds, cash, and commodities.
Over the short term, it is our belief that REITs will perform relatively well as the Federal Reserve appears committed to keeping interest rates low into 2014. In our opinion, investors seeking yield will put a floor under REIT prices. Long term, we do not see much potential for price appreciation as dividends will increase and prices will stay relatively flat as dividend yields revert to historical levels.
Click to learn more about CLS’s ETF Managed Income Strategy, which utilizes REITs.
Content provided by Matt Chadwell, CLS Investment Research Analyst
This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. A real estate investment trust (“REIT”), generally, is a company that owns income-producing real estate or real estate-related assets. Investing in REITs involves certain unique risks in addition to those risks associated with investing in the real estate industry in general. Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors. REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations. A REIT’s fund’s tax status as a regulated investment company could be jeopardized if it holds real estate directly, as a result of defaults, or receives rental income from real estate holdings. 1890-CLS-11/16/2012