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Beyond Stocks and Bonds: The Case for REITs in Your Portfolio

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Real estate is the third largest asset class in the world, behind stocks and bonds. It is a diverse asset class, including office buildings, apartments, storage facilities, industrial warehouses, hospitals, and cell towers, to name a few.

It can be difficult for everyday investors, however, to obtain diversified exposure to real estate. This is why publicly traded mutual funds and exchange-traded funds that hold real estate investment trusts, or REITs, can play an important role in a diversified portfolio.

REITs are legal entities that own, finance, and manage real estate properties. REITs are required to distribute 90% of their taxable income to shareholders, helping generate income for portfolios while allowing for capital appreciation. Because their historical returns have not always been closely correlated with either stocks or bonds, REITs can also dampen overall portfolio volatility.

Just like stock and bond mutual funds can hold hundreds or thousands of securities, REIT funds — often comprised of many individual REITs — offer diversified exposure to thousands of properties around the world.

Location, Location, Location

Today, there are more than 900 publicly traded REITs operating in more than 40 countries around the world, with a combined market capitalization of roughly $2 trillion. In the U.S. alone, there are approximately 580,000 REIT-owned properties in 17 different sectors, as outlined below:

Through our portfolios, Vista clients gain exposure to a diverse range of properties, from Washington Square Mall in the Portland metro area to the Empire State Building in New York City, as well as data centers in Asia, hotels in Europe, and many more.

Performance in Perspective

REITs have faced performance headwinds the past several years. Inflation hit a 25-year high in 2022 at 9%, leading many central banks to increase their benchmark interest rate. Higher interest rates can lead to financing challenges and drive property values lower.

The COVID-19 pandemic also negatively impacted office and retail REITs, with the transition to remote work pushing vacancies to record highs.

As of November 2024, the performance of both U.S. and international REITs was negative for the trailing three years and was significantly lower than the U.S. stock market over the prior decade. It’s no wonder investors are asking if REITs still deserve a place in their portfolios.

It is important to remember, however, that extended periods of underwhelming performance aren’t unique to REITs or real estate; in fact, many other important asset classes have periodically disappointed investors.

For example, U.S. small cap value stocks — the highest returning major asset class since 1926 — posted an annualized loss of 10% for the 10 years ending in 1938. Similarly, long-term U.S. government bonds — historically one of the safest asset classes — returned just 0.5% per year from 1960–1970. Even the S&P 500 Index has suffered several decade-long periods of negative performance in its history.

While the recent period of REIT underperformance has been challenging for investors, it wasn’t too long ago that investors were clamoring for more REITs. At the end of 2019, U.S. REITs had returned 11.1% per year over the prior 20 years, dramatically outpacing the S&P 500 Index by 5% per year.

REITs’ more recent performance woes have led to lower valuations and more attractive yields. Their continued lack of correlation with stocks and bonds, and potential for inflation protection, are additional reasons to remain optimistic.

Vista’s Approach to REITs

At Vista, we use highly diversified, low-cost mutual funds and exchange-traded funds to provide clients with broad exposure to REITs across U.S. and international markets.

A globally diversified portfolio that allocates to different asset classes, sectors, and geographies can help effectively manage risk and capture the attractive returns markets have historically delivered. U.S. and international REITs are a small, yet important, part of that effort.

The key to successful investing isn’t about predicting which asset class, industry, or geography will perform best next year.  It’s about sticking to an appropriate asset allocation, minimizing costs and taxes, and maintaining long-term perspective when it inevitably seems uncomfortable to do so.

In Today’s Market, Is Cash King?

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It has been more than 15 years since cash yields last reached 5%, and these higher rates have many investors wondering whether it’s time to seek the security of cash.

While this may feel safe, there are many reasons to avoid crowning cash king.

Cash Can Be a False King

In the short term, earning 5% in savings accounts, money market funds, CDs, and T-Bills can feel good since you can also avoid the roller coaster ride of stock market volatility.

But a settled stomach can quickly turn sour when you consider keeping too much in cash can leave money on the table.

Consider a $50,000 investment made thirty years ago in one-month US Treasury bills, continually reinvested. That $50,000 would today be worth $95,000.

The same sum invested in a balanced portfolio of stocks and bonds (S&P 500 and Bloomberg US Aggregate Bond Index) would have grown to more than $450,000 over that time.

That’s over $350,000 of lost opportunity—a high price to have paid for temporary peace of mind.

What Cash Giveth, Inflation Can Taketh Away

While foregone wealth is one drawback to holding cash, there’s also the significant risk of lost purchasing power.

Since the mid-1990’s, the return on cash has been lower than the rate of inflation in 46% of all rolling 12-month periods. This has meant the “real return” after inflation has been negative nearly half the time.

While that isn’t always felt in the short run, it can be devastating over the long run. Remember our example of the $50,000 investment in T-bills, which grew to $95,000 over thirty years? Adjusted for inflation, that $50,000 would purchase just $46,000 of goods and services today.

The table below highlights the historical annualized returns of stocks, bonds, cash, and inflation. While stocks have been the “riskiest” on an annual basis, cash has more frequently delivered a negative 12-month return, after accounting for inflation. This may come as a surprise to many investors.

High Interest Rates Don’t Signal Stock Market Losses

Some fear today’s high short-term interest rates (aka cash yields) imply low future stock returns, thus increasing the attractiveness of cash.

This fear has theoretical justification in how asset prices are determined. At its simplest, the price of an asset today is the discounted sum of its future cash flows, profits, or dividends.

As the graphic below shows, however, there is little correlation between historical yields on US Treasury securities and subsequent calendar year stock returns.

 

If the level of interest rates did influence subsequent stock returns, we’d see a clear pattern in the data presented above.

Instead, we see a random scattering of dots—indicating there is no clear relationship between starting interest rates and subsequent stock returns.

Clearly, today’s level of interest rates is far from the only factor influencing stock returns.

Consider the Journey, Not the Moment

While holding cash may feel reassuring in the short term, cash is not king in the long run.

Cash is more likely than stocks and bonds to lose purchasing power over time, increasing the risk of falling short of long-term goals, such as retirement spending or leaving assets to heirs or charity.

While holding cash for an upcoming purchase or tax bill makes sense, a diversified stock and bond portfolio has historically been the best way to protect and grow your nest egg.

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1 Vista calculations using CRSP, Morningstar, and Bureau of Labor Statistics data. Frequency of outperformance compared to CPI from 1/1/1973 to 9/30/2023. Total returns for US stocks, as measured by the CRSP 1-10 Market Index, and cash, represented by 1-Month US Treasury Bills, vs. the US Consumer Price Index.

The Bear Necessities

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Disappointing performance over the past few weeks has pushed U.S. stocks to new lows for the year and back into “bear market” territory. A bear market is typically defined as a drop of 20% or more from a recent high.

Investors may naturally wonder if more market pain is yet to come and, if so, should they be doing something different? While we’re not prone to offering forecasts, we believe the “bear necessities” of successful investing are no different today than they’ve ever been.

Looking Up While We’re Feeling Down

Despite the very real, and long list of, concerns we’re facing around the world, the simple truth is market downturns happen. That’s to be expected.

Sure, investors can point to what makes today’s environment different from the past and allow that uncertainty to erode the confidence they have in their current plans and portfolios, but investing is always uncertain. It is precisely the nature of risk that provides compensation to those willing to bear it. When risk shows up, we should embrace it for what it is—an expected part of the plan.

And, if we temper our emotions and take a step back, we see that bear markets—like the one we find ourselves in today—have historically been far fewer and much less intense than the bull markets that have preceded and followed them.

The graphic below shows stock market returns, divided into bull and bear markets, since 1926. Bull markets are shown in green and bear markets in red. The percentage return labels associated with each period indicate the cumulative gain or loss for each bull and bear market, respectively.

The keen observer will notice there are 35 periods on this chart, with just one more bull than bear market. Despite an almost equal split between good and bad periods, the magnitude of bull markets is hard to miss.

Underlying the graphic above are a few powerful statistics:

  • The average length of a bear market has been 10 months, while the typical bull market has lasted 55 months.
  • The worst bear market saw stocks fall a stunning 80%; the strongest bull market saw stocks surge more than 900%.
  • The average drop for stocks during a bear market has been 35%, while the average gain during a bull market has been 250%.

The takeaway? Despite many setbacks, stocks have delivered handsome rewards to disciplined investors.

Why Not Escape the Worst?

You wouldn’t be human if a part of you didn’t look at the graphic above and wonder how you could avoid the “red” and get back in time for the “green.” You can thank the hardwiring in your brain for that.

The problem is, while it’s easy to see the turning points from bear to bull in hindsight, it is nearly impossible to spot them in real time. Plus, some of the market’s best returns have often arrived while employment, geopolitical, and other news is still bad. By the time the economic news turns positive, prices have moved higher. You don’t get good news and low prices.

Missing just a few good days, too, can take a real dent out of the mountains of green. Consider that the annualized compound return of the S&P 500 Index was 10.7% from 1990 through 2021. But, if you’d missed the best 25 days—fewer than one day per year, on average—returns were nearly cut in half, to just 5.6%.

Enduring Wisdom

Investing isn’t about trying to beat the market by guessing whether it’s about to flash red or green. It’s about temperament, prudence, and favoring what’s probable over what’s possible.

Successful long-term investing is about adhering to time-tested principles such as asset allocation and diversification, disciplined rebalancing, and working to drive down costs and taxes. It’s about controlling what we can control and not worrying about the myriad factors we can’t.

This approach may not sound so flashy. But history is strongly on the side of investors who accept occasional downturns—like the bear market we’re all in together—as the cost of long-term investment success.

Will I Be Taxed on the Sale of My Home?

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Putting a house on the market this spring and anticipating a windfall?

You’re not alone. With soaring home values nationwide, many homeowners can expect a tidy profit from selling their home—well into the hundreds of thousands of dollars, depending on location and length of time in the home.

With profits such as these, will taxes take a huge bite from proceeds?

Not necessarily.

Hitting New Highs

In the last 10 years, median home values across the country have increased about 100%. 1

Some cities, such as Portland, have seen even greater appreciation. A decade ago, the median home value in the Rose City was about $225,000. Today it’s about $550,000—an increase of almost 145%, with prices projected to increase even more in the next year.1

When it comes to real estate values—and potentially huge profits for sellers—the western states rank high. According to Zillow, Hawaii has the highest median home price nationwide, with California, Massachusetts, Colorado, and Washington rounding out the top five. Oregon ranks number nine.

With values such as these, sellers may be concerned about capital gains taxes, which can rise above 30%, depending on your state and income level.

Exclusions to the Rescue?

Fortunately, IRS exclusions often mitigate the lion’s share of capital gains. Single filers can exclude up to $250,000, and married couples filing jointly can exclude up to $500,000 of profit from the sale of a home.

There are rules around these exclusions, however:

  • To qualify, the home must have been a primary residence two of the last five years, though the years do not need to be consecutive.
  • This requirement is reduced to one year for a person who has become physically or mentally unable to care for themselves. Time spent living in a nursing home or other health care facility counts toward this one-year requirement.
  • Snowbirds or those who alternate between two residences can only designate one property at a time as a principal residence (usually the one listed on the homeowner’s tax return).
  • Homeowners can take the capital gains exclusion only once every two years.

It’s worth noting partial exclusions—prorated by the number of days spent in a home—are available for a variety of reasons, such as a change in workplace location, health issues, or “unforeseen events” like divorce, the birth of twins or triplets, or a change in employment status.

When Profits Outstrip Tax Thresholds

But what happens when proceeds from the sale of a home exceed IRS thresholds?

Sellers must calculate their taxable gain, which is the home’s sale price, less selling costs, tax basis (more about that soon), deductible closing costs, and the IRS exemption.

Calculating a home’s tax basis can be quite complex. Many home improvements, such as additions, landscaping, and a new roof can increase basis. But there are many exceptions, such as maintenance (painting, fixing leaks) that keeps a home in good condition but doesn’t add to a home’s basis.

If you ever depreciated your home on your taxes (say it was a rental property at one point), depreciation recapture also needs to be taken into account when determining your taxable gain.

Homeowners who anticipate a large profit from the sale of a home can refer to this publication or consult with a tax preparer to determine tax basis—and potentially lower their taxable gain.

Planning Ahead

As we enter peak selling season, we encourage you to consult with your Vista team if you have questions or concerns about putting your home on the market. We’re happy to talk through ways to minimize taxes, and we can connect you with a qualified tax professional.

If you’re further along in the process, we recommend you obtain and provide accurate tax basis for your home to the closing agent (realtor, title company, escrow company) who will prepare tax form 1099-S. This will help you avoid filing headaches next tax season.

 

 1 Than Merrill. “Portland Housing Market: Prices, Trends & Forecasts 2022.” FortuneBuilders. Found at Portland Housing Market: Prices, Trends & Forecasts 2022 (fortunebuilders.com).