Investors have been drawn to the commercial real estate (“CRE”) asset class for decades for the twin wealth builders: Cash Flow and Appreciation.
Some CRE segments even thrive during recessions and inflationary times. Now, with inflation in the air, investors may lean to the CRE class more than ever.
There is a right way and a wrong way to invest in CRE, and REITs are the wrong way to do it, especially during rising prices.
Here’s why I would never invest in REITs:
Many are drawn to REITs because of the 90% rule, which requires REITs to distribute 90% of their “taxable income” to investors every year. Heck. 90%? Now that’s putting investors first. Wrong!
Read the fine print, and you’ll discover that 90% of taxable income is not the same as 90% of profits. Taxable income is what you get after eating away at profits with management fees and executive salaries, and that’s how REITs screw investors, and that’s the one big reason I would invest in a private real estate fund before I invested in a REIT.
With REITs, distributions to investors can be eaten away by management fees and salaries before any profits get into investors’ hands. Contrast that with private real estate funds, where investors typically get paid first.
The deceptive management-friendly 90% rule is one reason I’d never invest in REITs, but the fact that they’re publicly traded is the other reason. Although CRE is illiquid, REIT shares are not.
In a recession, REIT share prices are prone to sink just like any other stock. In the early days of the pandemic, REIT stocks nosedived along with the rest of the stock market in early March of last year. In contrast to REITs, Illiquid private investments in CRE are insulated from rampant stock market volatility during a downturn.
Direct CRE investments can not simply be liquidated in just a matter of minutes, hours, or days like REITs. And passive investments in CRE have rigid transfer restrictions – with lockup periods of at least five years or more. This illiquidity shields private CRE investments from the madness of the crowds REITs are susceptible to.
As for recession, REITs are bad not only because the stock market never reacts to inflation positively but because rising prices mean rising wages, which eats away at that taxable income even more – leaving less for investors than during normal times.
I would never invest in REITs during normal times, but I’d invest in them even less during recessionary or inflationary times. Unlike private CRE investments, REITs are not Wall Street crash-resistant, and they’re poor hedges against inflation.
I prefer private CRE funds over REITs for their non-correlated superior returns, and the data backs this up.
Based on the NCREIF (National Council of Real Estate Fiduciaries) Property Index, a reliable measure of private commercial real estate fund performance and the NAREIT (National Association of REITs) All Equity REITs Index, a reliable measure of public REIT performance, private real estate funds delivered an average annual return of 6.6% vs. 5.5% for public REITs over the past 20 years.
