REITs have outperformed the S&P 500 on a total-return basis over the past 1-, 3-, 5-, and 10-year periods. We at Standard & Poor's Equity Research Services attribute this outperformance to the fact that much of REITs' total return comes from dividend income, which can never be negative. That makes REITs less volatile than the broader market over the long-term, in our view.
Historically, the financial performance of REITs has tended to lag behind the economy by several quarters. Experts believe this lag in performance can be traced to the varying lengths of leases. Lodging REITs, which operate hotels, can re-price rooms on a daily basis, making them one of the most economically sensitive property types.
At the other end of the spectrum, office REITs typically have significantly longer average lease terms, often 10 to 20 years. As a result, they tend to have more stable earnings in an economic downturn, but also take longer to exhibit growth as the economy recovers.
In addition, REIT share prices tend to reflect the market price of commercial real estate. In the late 1980s and early 1990s, a confluence of events — including an overhaul of the U.S. tax code, the savings and loan crisis, recession, and war — depressed commercial real estate values. As a result, the government set up the Resolution Trust Corp. to auction off foreclosed properties. Many of the largest-cap REITs were established during this period, and began building their portfolios by buying properties at depressed prices at the RTC auctions. Long-term investors in these REITs have seen their share prices appreciate considerably over the past decade as commercial real estate prices recovered.
REIT stocks were notably weak in early 2005, and experts attribute this to portfolio rebalancing by investors and fear of rising interest rates, among other things. Because REITs outperformed the broader market in the past few years, investors wishing to allocate a certain percentage of their investment portfolio to REITs have had to sell REIT shares and reinvest in other sectors in order to maintain proper portfolio balance.
