Real estate is often described as being “recession-proof”. In fact, a recent article on Inc.com entitled “How to Start Investing If You’re Scared of a Stock Market Crash” lists investing in real estate and REITs as one of the top strategies to use to mitigate investment risk in a volatile stock market.¹
But is that really the case? In this article, we’ll examine how real estate and REITs have historically performed during bear markets and periods of stock market volatility.
Options for investing in a down market
The average annual return on the S&P 500 has been 13.79% over the last 10 years.² In June 2019, Forbes noted that this trend of double-digit returns may be coming to an end, thanks to the risk of rising interest rates, a drawn-out trade battle between the U.S. and China, and renewed confrontations with Iran.³
If and when the stock market becomes unstable, Forbes suggests five potential options for investing before problems begin to occur:
- Hold cash on the sidelines
- Purchase high dividend-paying stocks such as Pepsi, McDonald’s, and Exxon
- Add some weight in your portfolio to low-cost index value funds since value stocks, in general, are inexpensive relative to other stocks
- Move into sectors likely to outperform the market, such as healthcare and energy
- Invest in real estate investment trusts (REITs)
REITs and the CBOE Volatility Index (VIX)
To understand why investing in REITs may be a strategy to use if the stock market becomes volatile, we’ll first look at how REITs work and then how the VIX is used to measure stock market volatility.
REITs – Real Estate Investment Trusts
REITs are the stocks of companies that invest in investment-grade commercial real estate such as office building and multifamily apartment projects.
Directly investing in high-quality real estate requires large amounts of time, market knowledge, and capital. REITs allow investors to avoid the challenges of direct ownership while still receiving the benefits that investment real estate offers, including the potential for recurring dividend income and property appreciation.
The IRS requires REITs to pay out at least 90% of their taxable income to shareholders annually as dividends. When dividend payments are made, investors receive a regular income stream from the REIT, similar to the recurring rental revenue from owning real property directly.
By looking at an Index of REITs we can compare REIT performance to the stock market as a whole. The MSCI US REIT Index is composed of equity REITs that primarily own and operate income-producing real estate assets.⁴ Over the past 10 years, the MSCI has provided investors compounded annual returns of 15.42% vs. 13.79% compared to the S&P 500.⁵
VIX – CBOE volatility index
The VIX, or Volatility Index, was created by the Chicago Board of Options Exchange and is used by analysts to measure the stock market’s expected price fluctuations or forward-looking volatility.⁶
The VIX also measures both the frequency and magnitude of price movements up and down over certain periods of time. The more dramatic the price changes, the higher the level of volatility. In addition to measuring short-term price swings, expected future volatility measures price changes implied by options prices while realized volatility is used to measure actual historical price changes.
Historic performance correlation of REITs vs. equities
Correlation is a financial statistic used to measure the degree to which two investments or assets move when compared to one another. If both move up or down at the same time, they are said to be highly correlated. On the other hand, if one asset moves down while the other remains stable or moves up, correlation is said to be low or even negatively correlated.
Low correlation and diversification
In their report “Real estate: Alternative no more”, J.P. Morgan Asset Management analyzed the historical performance of commercial real estate to the performance of stocks and bonds.⁷ Describing the private real estate investment universe as too significant to ignore, J.P. Morgan noted that:
- Real estate has historically delivered performance that falls between equity and bonds – but is underpinned by a bond-like yield and with lower volatility when compared to equity
- Real estate’s low volatility cash flow offers support for stable returns with payouts that can grow in line with cash flow, unlike bonds that pay out a fixed coupon rate
According to J.P. Morgan, historically real estate also provides a foundation for low correlation to equity performance and a strategic opportunity for portfolio diversification.
Using data collected from the National Council of Real Estate Investment Fiduciaries, Barclays Capital, Wilshire, and J.P. Morgan the report compared the performance of private real estate to a 60/40 U.S. stock and bond portfolio over the 20 worst quarters between 1990 and 2008. In 17 of those 20 quarters, private real estate investment returns were positive while the portfolio of stocks and bonds was down.
Forward expectations for REITs
Of course, past performance is no guarantee of current or future performance. In January 2019, NAREIT – the National Association of Real Estate Investment Trusts – reviewed the returns, volatility, correlation, diversification benefits, and forward expectations for REITs.⁸
NAREIT tracked the daily total returns between the broad stock market and equity REITs for 2018. The REIT-stock correlation ranged from a low of 45% to a high of about 60%. While the Financial Times noted that “Stock market slide in 2018 leaves investors bruised and wary”, the low correlation between the stock market and REITs may help to protect investors from stock market volatility.⁹
In addition to looking at the recent REIT-stock correlation, NAREIT also employed another methodology to measure volatility known as REIT beta. Beta measures the risk of a specific asset compared to a benchmark such as the overall stock market. For example, a beta of 1 means an investment moves along with the market. A beta of 1.3 means an asset is 30% more volatile compared to the overall market, and a beta of 0.7 means it is 30% less volatile.
NAREIT found that throughout 2018 the REIT beta ranged from a low of 0.33 to a high of 0.85, with a long-term median beta of 0.51. Based on both low REIT beta and low REIT-stock correlation, NAREIT concluded that investors holding shares of REITs in their portfolio see less volatility than those with holdings in the broad stock market.
Do REITs cost more to invest in?
If REITs potentially offer shelter from stock market volatility, one might expect investors to pay more for the privilege of that anticipated protection.
Researchers from Johns Hopkins University attempted to answer this question by analyzing the VIX Index, volatility measures from the S&P 500 and Russell 2000 indices, and by employing other empirical research methods.¹⁰ They found that systemic volatility risk is not priced into equity REIT stocks. The research group also noted that this is in direct contrast to what is observed in typical non-REIT equities such as FAANG stocks and blue-chip, high dividend-paying stocks.
The Johns Hopkins research paper went on to note that:
- REIT performance is distinctively different from non-REIT equities
- Investors may be able to use REITs to hedge their portfolios against innovations in aggregate market volatility
- Typically, REITs are not sensitive to aggregate volatility found in large S&P 500 stocks or smaller stocks in the Russell 2000
Preparing for a potential bear market
The Dow Jones Industrial Average has gone from a low of 6469 in March of 2009 to 26,599 as of the end of June 2019.¹¹ While there’s no such thing as a crystal ball, given the cyclical nature of markets it may not be unrealistic to begin preparing for a bear market.
Of the five potential options suggested by Forbes for investing in a volatile stock market, real estate financed with fixed-rate debt may protect investors against rising interest rates. Simultaneously, properties with periodic rent adjustments such as multifamily can perform well during an inflationary period.¹² Consider investing in MogulREIT II , our REIT that invests exclusively in the multifamily asset class, as a way to potentially protect your portfolio from stock market volatility and prepare for a potential bear market.
Disclaimer: All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. We suggest that you consult with a financial advisor, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity.
Investing in MogulREIT II’s common shares is speculative and involves substantial risks. The “Risk Factors” section of the offering circular contains a detailed discussion of risks that should be considered before you invest. These risks include but are not limited to illiquidity, complete loss of capital, limited operating history, conflicts of interest and blind pool risk. MogulREIT II’s multifamily investments can be subject to specific risks including changes in demographic or real estate market conditions, resident defaults, and competition from other multifamily properties. MogulREIT II’s multifamily investments can be subject to specific risks including changes in demographic or real estate market conditions, resident defaults, and competition from other multifamily properties.