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Real Estate Investment Trusts (REIT): 2021 Outlook
The past year has been exceptionally volatile for the real estate industry and, naturally, this increased volatility has directly affected the real estate investment trust (REIT) market. The values of most REIT and REIT-adjacent companies have experienced wild price swings over the past twelve months, both in positive and negative directions.
Navigating the ever-changing real estate investment market can be challenging. There are many variables that can affect the value of REITs, including broad market demand, regulations, changing in consumer preferences, and more. Furthermore, it is important to realize that not all REITs move together—while some, such as those focusing on investing in multi-family homes or warehousing, might be experiencing increases in value, others, such as those heavily invested in traditional office spaces, might be moving in a different direction.
Regardless, taking a time to better understand the REIT market (and real estate industry, in general) can help you make well-informed choices as an investor. In this article, we will discuss the most important things you need to know about REITs, including the pros and cons of investing in REITs and how REITs might perform throughout 2021.
What is a Real Estate Investment Trust (REIT)?
“REITs, or real estate investment trusts, are companies that own or finance income-producing real estate across a range of property sectors.” REITs have existed, and have been accessible to all interested Americans, since the 1960s.
The primary goal of a REIT is to create a profit for investors. REITs do not usually focus on simply flipping properties (like some other real estate-focused firms might do), rather, they try to find properties that can generate future revenue streams that are greater than future expenses. This might include residential rental properties, commercial properties, industrial properties, and many others. Profit is typically generated through ongoing rents, along with asset appreciation and development. Some REITs are registered with the Securities and Exchange Commission (SEC) and are publicly traded.
What are the Pros and Cons of Investing in REITs?
As is the case with all speculative investments, investing in REITs has both pros and cons.
The pros of investing in REITs include:
- Liquidity: rather than investing directly in real estate (which is usually illiquid), REITs enable investors to have an indirect, highly liquid stake in the market.
- High Demand: real estate is an asset that will always be in demand and, due to the physical (real) nature of the asset, will always have limited availability.
- Total Return: REITs can generate returns in several different ways, including asset appreciation, rent, and property enhancement.
- Strong Returns: REITs generally outperform the stock market as a whole (as measured by the S&P 500 Index), without creating excessive additional risks.
On the other hand, some of the drawbacks of investing in REITs include:
- Dividend Taxes: currently, REIT dividends are not considered “qualified dividends,” meaning you may end up needing to pay more taxes than you initially expected.
- Long-Term Investments: real estate development can take quite a bit of time—it may be several years before properties begin generating net-positive returns.
- Uncontrollable Variables: there are many things that can cause REITs to underperform, including property-specific variables, legislative changes, and broader economic downturns.
How well did REITs Perform in 2020?
2020 was a very volatile year for most sectors, and REITs are no exception to this broader rule. REITs focused on hotels and office spaces saw sudden spikes in vacancies that negatively impacted their values. On the other hand, multifamily and industrial properties experienced surprisingly stable growth.
Essentially, whether a given REIT was able to perform well in 2020 largely depended on how strongly their properties were connected to the COVID-19 outbreak.
Overall, REITs still managed to have a fairly productive 2020, especially towards the end of the year. According to one estimate from September 2020, “After suffering losses in five of the first seven months of the year, the REIT sector bounced back in August, averaging a +3.16 percent total return.”
Towards the beginning of the year, large cap REITs notably outperformed their small-cap counterparts, but by the end of the year, small-cap REITs took the lead. This is relatively unsurprising, given the volatile nature of the year as a whole (during periods of volatility, small cap REITs tend to experience higher highs and lower lows).
With the broader reopening of the economy, many properties that experienced steep price drops at the beginning of the year are looking forward to making a highly anticipated comeback.
How are REITs Likely to Perform in 2021?
The REIT industry, as a whole, has already yielded strong results for 2021. Recent reports indicate that “REITs extended their 2021 winning streak with a +3.02 average total return in March.” Furthermore, about three in four (74.73 percent) of REIT securities yielded a positive return in March, making March one of the best-performing months for REITs in recent history.
There are several forces that will likely cause REITs to continue their rally throughout the course of the year. Heavy government investment, paired with still low (but not as low as they once were) interest rates can help ensure that demand remains high. Additionally, the removal of restrictions and an eagerly awaiting population will likely cause a spike in demand for office space, retail space, and other people-focused spaces. Even if demand does not reach pre-pandemic highs, the dramatic downswings that were witnessed at the beginning of the pandemic leave plenty of room for growth.
At the same time, there are still reasons to be cautious when investing in REITs. Delayed revenue streams might cause once promising REITs to underperform. Additionally, expected near-term inflation might also create problems for investors as rents will inevitably need to rise (which may stifle demand). Keeping this in mind, nobody should consider REIT investments to be risk-free.
Overall, it is clear that the REIT market turned around toward the end of 2020 and is enjoying a productive early 2021. With a diversified approach to the market, a willingness to look at company-specific risk, and patience, becoming a REIT investor can still be a very lucrative endeavor.
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