A reader asked for my two cents on Burton Malkiel's assertion that investors should have at least 10% in real estate securities. The reader wanted to know if 10% is necessary, where his home fits into the mix and if exposure to things like Walmart and McDonalds should count.
There are a couple of different things at work here. First is the idea of investing in REITs to capture a real estate effect, specifically commercial real estate. Another big draw is the low correlation to stocks and accompanying high dividend yields.
Most of what I could offer here will be subjective, I don't think there is a hard right or wrong.
I maintain much less than 10% in REITs. Most clients are 3% or so and some clients who are less tolerant of volatility have 6% or so. I can't say 10% is wrong but just not where I want to position.
Personally I don't think of my home as an investment in the context of how it balances out my portfolio. When we first bought our house it was a second home and so maybe then it made sense to think of it in terms of our portfolio then but we have been living here full time for several years now, with no plans of selling anytime soon so its value has no significance to my portfolio. Plenty of folks would view this differently and that is very valid but whether my house is worth $100,000 or $600,000 plays no role in how I manage my own portfolio. I would feel differently, I suppose, if I were going to sell soon.
As far as whether McDonalds (MCD) and Walmart (WMT) capture the effect; I'd say no. These companies and companies like these may benefit from real estate to be sure but I don't think they capture the effect. Using streetTRACKS REIT Fund (RWR) as a proxy, WMT has a 0.33 correlation while MCD correlates at only 0.29.
To me this is similar to the question of whether a multinational that sells to China captures the China effect; it doesn't.
To get even fuzzier, there is another aspect to REITs which is what they offer to a diversified portfolio. Typically they offer lower volatility, higher yield and more predictability than equities. This is desirable within a portfolio but REITs are not the only type of thing that brings these attributes to the table. While I don't have 10% in REITs it might be correct to say I have 10% in holdings that behave similarly to REITs most of the time. If REITs ever get pasted it is reasonable to think that some of these other areas that behave similarly might hold up just fine but of course there is no way to know for sure unless a crisis ensues.
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17 comments:
1. I agree with the 10% in the REIT sector, spread out over sveral commercial sectors.
2. I heard somehwere (Ray Lucia) that the REIT index closely follows the small-cap value index over the long term in terms of performance and tracking.
not sure exactly what Ray is looking at so tough to comment but according to PortfolioScience RWR (again as a proxy) has a 0.61 correlation to SPY and a 0.62 correlation to iShares Small Cap Value (IJS). These numbers only go back one year which all they data they offer.
To throw another question into the mix; did you read Richard Kang's article on foriegn real estate securities (ETF section on seekingalpha.com)?
Any allocation thoughts on this?
Thanks!
I think it depends on the value of your current house versus what a retirement house will cost you. For example if my house is currently valued at 550K and I believe a retirment house could be had closer to 250K then I would think my house qualifies as a partial investment in realestate. Prices may fluctuate, but I do believe I will capture a sizeable gain from selling my house when I retire.
I know I can not get hold of the money now, but I do see it as an appreciating real estate asset that will one day be part of my retirement portfolio (well atleast part of it will be)
the $300k spread's relevance boils down to time doesn't it? If you are thinking five years, I agree there is relevance but far less so if your time is 20 years.
But really I think what you are talking about is more financial planning in which it is relevant regardless of time as opposed to portfolio management.
not much different if you would factor in a pension or inheritance into your plan.
just my take.
Now for something completely different...I was reading Apache Co. Weekly Energy Perspective (http://www.apachecorp.com) on where Natural Gas prices are headed. The entire US has never had this much Natural Gas under storage at this point before winter. This seems bearish for energy producers and bullish for consumers. If the US consumer gets through this winter with lower gasoline and heating bills, I can't see how there will be a slowing in consumption of capital goods (another argument against a hard landing). Tom in Indy
Tom in Indy,
that could be right. Barry Ritholtz has something up that points to mortgages going higher regardless of the Fed. For now I have no judgement on that but a part of your thesis has to rely on borrowing costs staying sort of low?
Rates staying low creates visibility for your scenario. My brother and I were talking about this yesterday; it seems like a lot of the bullish pundits talk about consumers accessing more equity to spend and talk less about the energy "tax cut."
Where I live it costs me $1200 for a year's worth of propane I do not know what it costs other people elsewhere to heat their homes with heating oil or anything else.
If energy goes down 20% from here I would save $240. If it costs other people $5000 per year they would have an extra $1000. Now consider that to some portion of the population the savings does not alter their spending because they are wealthy thus providing no boost in buying power.
I submit that cheap borrowing could be much more important than cheaper energy.
TomK I would need to see more about Intl RE. i would want to know how it correlates to everything else. There is a CEF, ticker RAP, that I wrote about for TSCM, that did not seem to be similar to domestic REITs but we'll see about the ETF.
I have to disagree with you the 300K difference is real wheter retirement is 5 years or 20 years away. I will concede it is more relavent for 5 years because it is not that great of an investment for 20 years (even though I do like the place).
It is more of a home than an investment in the long run. Still this 300K difference convinces me not to invest in REITs for now.
As I said in the post this is all subjective.
Part of my problem with this line of thinking is that I don't really feel like home prices in my area correlate to REITs at all.
The equity in my home matters in the context of my financial plan but I am hard pressed to convince myself that my home's equity adds anything to my account at Schwab.
REITs, foreign and domestic, have been holding up quite well; about a year ago they exceeded my strategic allocation limit and I cut back some but do not plan to add significantly in the foreseeable future as I'm seeing signs of inventory overhang in a number of foreign markets including China.
In my experience building cycles in foreign markets do not line up exactly with US building cycles and commercial RE frequently doesn't align closely with residential so diversification in RE has always seemed like a good idea to me -- e.g., holding a total 10% in RE would not bother me at all unless it were entirely commercial or in the US -- but I haven't done any systematic correlation studies to check that.
In terms of the macro environment I would expect a healthy economy, even one primarily driven by consumer credit expansion, to experience an accompanying increase in production to meet demand and hence an increased acquisition of capital goods (initiation of a new business cycle). But that's not what businesses have been doing much of for the past few years and they don't seem to be doing much more now with either the bulk of their cash or their borrowing: Share buybacks and M&A, yes, but relatively little capex in the US (there appears to be relatively more capex in international markets but that's not easy to get a complete read on).
That said, there still seems to be a fair amount of foreign money flowing into US financial assets, bonds mostly but equities too (e.g., http://www.treas.gov/tic/ ) so I'm guessing things will be okay for awhile longer ...at least until they're not.
Two article based on a WSJ article last week:
http://etf.seekingalpha.com/article/18686
http://etf.seekingalpha.com/article/18875
“The State Street fund will be based on the Dow Jones Wilshire ex-US Real Estate Securities Index."
Kang's article and subsequent post refers to Northern Global Real Estate Index Fund [NGREX] and Alpine Int'l Real Estate (EGLRX). Alpine has been around since the mid nineties if you want to look at a chart.
Ray Lucia, a very well respected Financial Planner, and Ben Stein both believe that up to 20% in a mixture of publicly traded and non-traded REITS is appropriate. They claim lower volatility and enhanced returns over the long run.
I guess you pays yer money and takes yer choice as the old saying goes.
I have to agree with you the 300K home equity does nothing for my brokerage accounts. But if I only have 900K in IRAs, taxable accounts etc.
The home equity represents 25% of my assets in real estate. Even if it poorly correlates with REITs, that is a lot of money in real estate IMO.
the equity matters but as I read your comment it seems like you are agreeing with the idea of mattering more to a long term financial plan than an investment portfolio.
at some point you may or may not need to access that equity. if not, it probably means little. If you do need to access it then it becomes more important to the investment part of your financial plan.
To me, a house represents a lifestyle not an investment. Over the long term real estate will underperform a diversified stock portfolio. Not like you can sell the house, move out on the streets, and live like a king...
REIT dividends are taxed at highest tax rate 35% while other qualified dividends are 15% if investment is in a taxable account.
On average approximately 20-25% of REIT dividends are treated as return of capital and are not taxed at all. The remainder of the dividend is considered ordinary income, not qualified for favorable treatment, and the level of taxation is therefore set by the individual's tax bracket; i.e., it is not fixed at 35% or anything else.
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