Investing In REITs: REITs As Alternatives To A Traditional Stock

In the previous article about investing in REITs, we talked about getting broad exposure through an ETF and highlighted several ETFs that could be used for that exposure. It is by far the easiest way to invest in REITs without worrying about picking individual stocks or sectors, but it does have its drawbacks. For example, in the case of market-cap weighted ETFs, you will have greater exposure to the larger REITs and little to no exposure to the smaller-cap REITs. On the other hand, some of the equal-weighted ETFs tend to be highly concentrated and therefore may be more volatile.

What we didn’t mention in the previous article that we think is important is what percentage of your portfolio to allocate to REITs. I hate to respond this way, but: It depends. It depends on each investor’s investment profile, which includes too many variables for me to properly answer.

However, if we look at the market capitalization of REITs within the S&P 500, as an example, real estate makes up just 3%. So as a rule of thumb, an investor looking for a baseline level of exposure to REITs should therefore use 3% as a “neutral” allocation within the large-cap allocation of their portfolio. From there, exposure could be added or reduced depending on personal preferences, views on the sector, income needs, etc. It sounds like an immaterial amount, but if you invested in the SPDR S&P 500 ETF Trust (SPY) you would have around 3% exposure to REITs.

REITs as Alternatives to Traditional Equities

The other way investors can use REITs is to use them as an alternative to traditional equities with similar performance drivers. The example we like to use is to use timber REITs for exposure to homebuilding.

In September 2012, I wrote an article about Weyerhaeuser (WY) and followed up with two more articles in 2014 and 2015. It has been a while since we’ve published an article on the company, but it is still a part of my personal portfolio and was added to the Heard on the REITs portfolio in early August. Since we first wrote about the company, the stock has returned over 40% to shareholders, which compares favorably to the MSCI US REIT Index (RMZ), with a return of 28.9% over the same period.

Comparing the returns on Weyerhaeuser to two of the home-related ETFs, you will notice that there is a strong correlation in the price movements of Weyerhaeuser, with those of the iShares US Home Construction ETF (ITB) and SPDR S&P Homebuilders ETF (XHB).

It’s not a perfect relationship,…

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