REITs offer strong long-term total returns. During the period from January 1978 through December 2012, equity REIT performance exceeded both the broad equity market and other forms of real estate investment by more than 1 percentage point per year, producing an average annual return of nearly 12.9 percent. As such, a $100 million investment in equity REITs at the beginning of that time period would have been worth more than $5,500 million by the end.
A comparison of real estate returns over rolling five-year periods for the period from January 1976 through January 2013 further illustrates the strength of REITs’ long-term performance. Equity REITs experienced 100 five-year periods during which their average annual total returns exceeded 20 percent. They experienced 85 five-year periods of average annual total returns between 15 and 20 percent.
Equity REITs use moderate leverage, on average approximately 40 percent; and use it very effectively. As a result, REITs offer favorable returns relative to leverage.
As the chart below shows, given a fixed gross return (based on the NPI) and a 6.50 percent cost of capital, REIT returns compensate investors over and above the return that would simply be achieved by using leverage, suggesting that REITs create additional value for investors in excess of the returns that should be achieved simply through financial engineering.
REITs have higher Sharpe ratios, in general, compared with other capital markets alternatives. The Sharpe ratio shows how efficient portfolio returns are relative to risk assumed in the portfolio. This measurement is very useful as a tool when deciding what assets to use in building a portfolio. The greater a portfolio’s Sharpe ratio, the better its risk-adjusted performance has been.
Excellent long-term performance and strong diversification attributes make REITs a natural component of a well-balanced, efficiently performing portfolio. Adding REITs to the typical investment portfolio can have a dramatic impact on its long-term stability and returns.