Nearly every client we work with owns some real estate. Why then do we utilize a real estate investment trust (REIT) in our portfolios? Let’s look at some of the rationale and take a peek at the longer-term performance.The real estate fund we use through Dimensional (DFREX), owns over 150 other real estate investment trusts so it is what’s known as a fund of funds. Each of those REITs, of course, own dozens of properties adding yet another layer of diversification.
Your Home is Not an Investment
While the home you live in provides utility in the form of shelter and a place for family, it isn’t historically an investment per se. Over long swaths of time, residential real estate has provided a return on capital of approximately the rate of inflation, plus or minus 1% per year. Therefore, it might be considered a reasonable storehouse of value
, but not an investment that will reliably produce premium returns above inflation.I’m not negative on residential real estate at all, but the investment aspects are mostly overstated.
My wife and I have owned our home for 31 years and based on rough market value estimates, the return we have accrued over that fairly long time-frame might be around 3% per year. Inflation (as measured by the CPI) has been about 2.5% per year for this period so perhaps the value has surpassed inflation by just a bit. When property taxes and upkeep are added in, this slightly above inflation return likely becomes slightly negative.
Real Estate Investments
That said, investment real estate has a far different track record. The chart below details some of the reasons we include real estate in client portfolios. REITs are a hybrid-type investment containing characteristics of both stocks and bonds. That is, they typically provide a relatively high dividend and have potential for capital gains over time as well.As this Randomness of Returns chart reflects, the Dimensional Real Estate Fund has either been the highest or next to highest performing asset class in 9 of the past 19 years. The next best performing asset class (again either highest or 2nd highest) is Emerging Markets with 8 years followed by U.S. Small Value with 6 years at one of the two top spots.
The chart above also has a couple incidental findings that are interesting. U.S. Large Company (S&P 500 Index) only has 4 years in the highest or 2nd highest spot while Five Year Global Fixed Income has zero years in the top 2 spots.Year by year returns are indeed random and we are not in any way suggesting a pattern, but that doesn’t mean certain asset classes won’t perform better than others over longer periods of time. Start there.Related: The Lure and Lunacy of Target Date Funds