What Is the Right REIT Allocation? (2024)

Commercial real estate is a core asset class with unique investment attributes and return drivers. This has been demonstrated over time and is the reason that 83 percent of financial advisors in the U.S. recommend REITs.

Investments in REITs are investments in real estate, providing the same long-term real estate returns and diversification benefits. The defined contribution and financial-advisor driven IRA markets are increasingly using REITs to add real estate exposure to diversified portfolios. In the defined contribution market, where the growing use of target-date funds is the dominant investment-related trend, it is estimated that nearly 100 percent of these products feature REIT allocations. Among financial advisors, a Nareit-sponsored survey conducted by market research firm Chatham Partners found that, despite the ongoing pandemic, 92 percent of financial advisors will maintain or increase their recommendation of REITs to their clients in the next one to three years.

The fundamental asset class proposition is based on specific, well-documented attributes of real estate investment, including:

  • A distinct economic cycle relative to the cycle for most other equities and bonds due to supply inelasticity, which reduces the correlation of investment returns from real estate with the returns from other assets,
  • Competitive, long-term investment returns that potentially provide high and growing income from rents plus moderate capital appreciation over time,
  • Potential inflation hedging attributes due in part to the fact many leases are tied to inflation and that real asset values tend to increase in response to rising replacement costs.

What is an appropriate REIT portfolio allocation?

REITs have provided above average returns while exhibiting low, long-term correlations with other major asset classes. Many investors believe a reasonable portfolio allocation to REITs is between 5 percent and 15 percent, and there are two research-based factors that support the idea that allocations to REITs in an optimally-diversified portfolio may be at the higher end of the scale for many investors.

First, commercial real estate is the third largest asset (17 percent) in the U.S. investment market, after U.S. equities (37 percent) and U.S. bonds (43 percent). Modern portfolio theory argues that well-diversified investment portfolios should include meaningful allocations to all assets in the market basket, including real estate. It is important to note that, while listed REITs only represent an estimated 10 percent to 20 percent of the above referenced 17 percent real estate asset figure, research by organizations such has Morningstarhas found that the real estate market drives REIT returns. For this reason, listed REITs and property companies may be used as a liquid and transparent proxy for gaining access to the entire commercial real estate market, which represents about one fifth of the investable universe in the U.S. It should be noted that listed real estate securities may also be used to invest in the global commercial real estate market.

Second, multiple studies from organizations such as Morningstar and Wilshire Associates have shown that the optimal allocation to listed Equity REITs for certain investors may be between 5 percent and 20 percent, and Wilshire found that the optimal allocation to listed U.S. Equity REITs in a retirement savings portfolio would begin at 15.3 percent for an investor with a 40-year investment horizon, and gradually decline along with other equities as the investment horizon shortens, ultimately to 9.1 percent for an investor at retirement. Not surprisingly, the maximum REIT allocation identified in these and other research studies was comparable to the proportion real estate represents within the U.S. investable universe. It should be noted that optimal portfolio allocations to global REITs and real estate companies were found to be similar.

REITs increasingly are being included in more meaningful allocations in investment portfolios—especially retirement portfolios. The use of REITs in portfolio design is indicative of the growing recognition that real estate exposure provides important benefits for investors.

Abigail McCarthy is senior vice president, investment affairs, with Nareit.

What Is the Right REIT Allocation? (2024)


What Is the Right REIT Allocation? ›

By combining REITs and private real estate, investors can improve upon their risk-adjusted returns. Empirical data suggests an optimal portfolio allocation to REITs of at least 10% of real estate investments.

What is the 75 75 90 rule for REITs? ›

Invest at least 75% of its total assets in real estate. Derive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate. Pay at least 90% of its taxable income in the form of shareholder dividends each year.

What is the 5 50 rule for REITs? ›

A REIT will be closely held if more than 50 percent of the value of its outstanding stock is owned directly or indirectly by or for five or fewer individuals at any point during the last half of the taxable year, (this is commonly referred to as the 5/50 test).

What is the 90% REIT rule? ›

To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.

What is a good payout ratio for a REIT? ›

Key Takeaways. Real estate investment trusts (REITs) are required to pay out at least 90% of income as shareholder dividends. Book value ratios are useless for REITs. Instead, calculations such as net asset value are better metrics.

What allocation should REITs have in a portfolio? ›

By combining REITs and private real estate, investors can improve upon their risk-adjusted returns. Empirical data suggests an optimal portfolio allocation to REITs of at least 10% of real estate investments.

What is the 80 20 rule for REITs? ›

In situations where all investors submit cash election forms, the dividend payout formula will result in all shareholders receiving their distribution as 20% cash and 80% stock, which means that the cash/stock dividend strategy functions analogously to a pro rata cash dividend coupled with a pro rata stock split.

What is the REIT 10 year rule? ›

For Group REITs, the consequences of leaving early apply when the principal company of the group gives notice for the group as a whole to leave the regime within ten years of joining or where an exiting company has been a member of the Group REIT for less than ten years.

How to tell if a REIT is good? ›

The 3 most common metrics used to compare the relative valuations of REITs are:
  1. Cap rates (Net operating income / property value)
  2. Equity value / FFO.
  3. Equity value / AFFO.

What is the 48 hour clause for REITs? ›

This condition allows the seller to continue advertising the property. If the seller receives another offer, the buyer will have 48 hours to revise their offer, making it unconditional regarding the sale of their property.

How long should I hold a REIT? ›

Is Five Years the Standard "Hold" Time for a Real Estate Investment? Real estate investment trusts (REITS) and other commercial property investment companies frequently target properties with a five-year outlook potential.

What is the outlook for REITs in 2024? ›

After lagging equities the past two years, REITs offer an attractive investment opportunity in 2024. The headwind of higher bond yields and central bank rate hikes is likely to abate and may turn into a tailwind if our view about an impending economic slowdown and decelerating inflation trends is correct.

Do REITs go down during a recession? ›

REITs historically perform well during and after recessions | Pensions & Investments.

What is the most profitable REIT? ›

Best REITs by total return
Company (ticker)5-year total return5-year dividend growth
Prologis (PLD)121.8%12.4%
Eastgroup Properties (EGP)107.9%13.3%
Gaming and Leisure Properties (GLPI)99.7%1.1%
Extra Space Storage (EXR)98.5%14.0%
4 more rows
Jan 16, 2024

Which REITs pay the highest dividend? ›

The market's highest-yielding REITs
Company (ticker symbol)SectorDividend yield
KKR Real Estate Finance Trust (KREF)Mortgage14.0%
Two Harbors Investment (TWO)Mortgage14.0%
Ares Commercial Real Estate (ACRE)Mortgage13.8%
Brandywine Realty Trust (BDN)Office13.6%
7 more rows
Feb 28, 2024

Can you live off REITs? ›

Reinvesting REIT dividends can help retirement savers grow their portfolio's investment, and historically steady REIT dividend income can help retirees meet their living expenses. REIT dividends historically have provided: Wealth Accumulation. Reliable Income Returns.

What is the 75 rule for REITs? ›

For each tax year, the REIT must derive: at least 75 percent of its gross income from real property-related sources; and. at least 95 percent of its gross income from real property-related sources, dividends, interest, securities, and certain mineral royalty income.

What is the 30% rule for REITs? ›

30% Rule. This rule was introduced with the Tax Cut and Jobs Act (TCJA) and is part of Section 163(j) of the IRS Code. It states that a REIT may not deduct business interest expenses that exceed 30% of adjusted taxable income. REITs use debt financing, where the business interest expense comes in.

Why do REITs have to pay 90%? ›

To qualify as securities, REITs must payout at least 90% of their net earnings to shareholders as dividends. For that, REITs receive special tax treatment; unlike a typical corporation, they pay no corporate taxes on the earnings they payout.


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