A proposal is afoot to add a real estate investment trust, or REIT, investment option to the Thrift Savings Plan. This investment option most likely would take the form of an index fund that tracks the performance of a large group of actively traded REIT shares. The TSP’s C, S, I and F funds also are index funds.
A REIT, pronounced “reet,” is a trust, association or corporation that pools investor funds for the purpose of investing directly in real estate or real estate mortgage loans or both. REITs typically produce a stream of current income from the rents or interest they earn and pass this income to investors as dividends. They may also produce capital gains from the sale of properties or mortgages, which are also passed through to investors as they are earned. In addition, the value of the REIT or REIT index fund shares, themselves, may increase or decrease in value and produce capital gain or loss when they are sold.
Some investors — asset allocators — consider real estate to be a unique asset class, distinct from others such as corporate stocks and bonds. This means that REITs may have the benefit of adding diversification to investment portfolios, thus helping to reduce portfolio risk without proportionately reducing long-term rates of return.
Other investors — market timers — might like to have access to REITs in order to speculate on upswings in the commercial or residential real estate markets. Indeed, REITs have been enjoying a multiyear bull market. Major REIT indexes, such as the Morgan Stanley REIT Index have recorded positive returns in seven of the last 10 years. Six of those seven positive years delivered returns in the double digits.
Sounds great, right? Well, that’s the sales pitch for investing in REITs. As with all investments, there are risks and other mitigating circumstances to consider as well.
To begin with, the value of REITs as a distinct asset class is widely debated. Real estate ownership, operation and financing are integral parts of the U.S. business economy and are already represented in the TSP’s current index fund offerings. When you own the C Fund, for example, you own real estate and real estate-related business. Rather than a unique asset class, in my view and the view of many others, real estate is more accurately a subsector of the broader equity and debt markets — an industry. So
offering a REIT fund is similar in concept to offering a separate technology, health care or financial services fund.
Additionally, many TSP investors already carry significant exposure to real estate in the homes and land they own.
So, offering a REIT fund in TSP doesn’t really provide access to a new asset class; it just enables investors to increase their exposure to real estate beyond what they already have or could have using the other TSP funds.
Timing the markets in real estate, like any other investment asset, is a risky game. It’s impossible to predict success, and it is impossible to reasonably estimate the effects of future market timing decisions on the risk and return characteristics of your portfolio. REIT share values can and do drop dramatically. So, planning your retirement — the purpose of TSP in the first place — would be complicated by the lack of predictability of your investment portfolio’s performance.
And, even devout market timers would surely be hesitant to jump into real estate at a point when so much price appreciation has already been realized. It always seems that the enticement to get into a particular market reaches its peak just as all the last of the great rags-to-riches stories are being told and the end is at hand. Is the real estate boom of the 2000s destined for the same fate as its “new economy” predecessor of the 1990s? Only time will tell.
For some years, I included REIT funds as part of the investment strategies I recommended to my clients. A few years ago, I discontinued their use. The decision was not based on my assessment of potential REIT performance over the coming few years, or even how far REITs had come in previous years. It was based on an analysis of the expected benefit of REITs to my clients’ portfolios over the coming decades. My analysis showed that, using expected rates of return, risk and correlation with other available investment assets, the addition of reasonable amounts of REIT investment did little, if anything, to enhance risk-adjusted expected returns. In other words, over the long run, my clients could expect to achieve virtually the same results from a well diversified portfolio without a REIT investment as they could from a portfolio that included a REIT fund. So can you.
Written by Mike Miles
For the Federal Times
Publication April 25, 2005