Are REITs better than Bonds?

Are REITs Better Than Bonds?

June 28, 2021

Are REITs Better Than Bonds?

This week’s reader question takes us into the realm of income-producing investments: Are REITs a good alternative to bonds in the current market? Are they a safe and solid investment overall?

Chris Keith, Senior Vice President, Fixed Income Manager. had this to say:

REITs can certainly be a sound investment, but they are not an apt bond replacement in a diversified portfolio. I’ll explain, but let’s start at the beginning.

REITs, or “Real Estate Investment Trusts,” pool investor capital to finance real estate ventures—think office buildings, shopping malls, industrial complexes, hospitals and hotels. Most REITs are publicly traded, which makes them far more liquid than investments in physical real estate, but it also means their prices are vulnerable to shifts in market momentum.

Like bonds, REITs generate a steady stream of income for investors. In most cases, 90% or more of the income from REITs goes back to shareholders in the form of dividends. And most REITs have higher yields than bonds—the caveat here is that they carry higher risk.

The value of your home changes over time…but the price of a REIT? It can change by the minute. And it’s this volatility that makes REITs an unsuitable substitute for bonds.

The chart below (showing monthly price returns of Vanguard Real Estate ETF and the Bloomberg Barclays U.S. Aggregate Bond index since the start of 2020) demonstrates the risks and appeal of owning REITs. From April 2020 through May 2021, as the economy and market recovered from the initial pandemic shock, REITs outpaced bonds by a significant margin, 43% to 2%. However, look at those declines in the first quarter—REITs fell 25% January through March 2020 while the bond market gained 3%.

 

Note: Chart shows monthly price movements of Vanguard Real Estate ETF (VNQ) and the Bloomberg Barclays U.S. Aggregate Bond index from January 2020 through May 2021; the bond index is not investable and is displayed for illustrative purposes only. Sources: Bloomberg and Adviser Investments.

 

In the current ultra-low-yield environment, it’s reasonable for investors to look for ways to boost the income generated by their portfolios, but if you’re selling bonds to buy REITs, you are assuming significantly more risk. The primary reason to own bonds is to protect your portfolio and offset stock market volatility. REITs can’t be counted on to do that.

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