Issue 04 - May 2013

REITs May Offer an Advantage for Investors

We came across an interesting chart on the overall returns of REITs vs. the S&P 500 and other indexes that we’d like to share.

As you can see below, the historical track record of REITs is pretty impressive. However the conclusions we take from this chart might be a bit different than you might guess at first glance.  In comparing the historical returns of REITs vs. the S&P 500 returns for example, you might conclude that commercial real estate is a superior asset class to stocks; after all, the REIT returns were higher in every time frame over the past 40 years.

Historical Compounded Annual % Total Returns of

REITs and Leading US Benchmarks:


S&P 500


Barclays Aggregate

US Equity REITs:

Total Return:

Russell 2000:

Bond Index:

1 Year





3 Year





5 Year





10 Year





15 Year





20 Year





25 Year





30 Year





35 Year





40 Year





* Data as of February 28, 2013
*  Source:  NAREIT

But when you break down the returns and consider how they are taxed, you will see that the gross returns for each of those asset classes were closer to equal.  If we look at the 40-year average returns for example, the S&P 500 averaged 10.08%.  During that timeframe, about 3% of that 10.08% on average came from dividends and the remaining 7% came from price appreciation or growth.  For the REITs, the 40-year average return was about 12.46%, of which about 5 to 5.5% was from dividends and the remaining 7% or so was from growth.  So if the growth was fairly equal, why were the RIETs able to pay out so much more in dividends?

The answer is in how the two assets are taxed at the corporate level.  REITs do not have to pay any tax at the corporate level as long as they distribute at least 90% of their earnings as a dividend to their shareholders.  Other corporations currently pay around 35% to 38% and over the past 40 years have paid as high as 48% on all income, whether it is paid out as a dividend or not.  Obviously, this is a major advantage for the RIETs.

When looking at our 40-year example and factoring in the tax rates, let’s assume an average tax rate of 40% for corporations.  That would mean that in order to pay out their 3% average dividend, corporations would have to earn closer to 5%.

  • For example, let’s say we have a Corporation and a REIT that both earn $1,000,000 ($1m) in profits.  They both want to pay out that $1m as a dividend and both are valued at $20m based on their current stock prices.
    • The Corporation would first have to pay their tax bill, which at 40% would be $400,000, leaving them with $600,000 to pay to shareholders as a dividend.  $600k divided by their $20m value would mean they paid out a 3% dividend.
    • The RIET would not owe any tax (as long as they pay out more than 90% of their income), meaning the entire $1m could be paid out to shareholders as a dividend.  $1m divided by their $20m value would mean that they paid out a 5% dividend.

Historically, this tax advantage for REITs has resulted in approximately a 2% per year higher dividend payout vs. the S&P 500.  This essentially accounts for the difference in the long-term returns between the two asset classes.  Going forward, we are certain that there will be time periods when the S&P 500 performs better than the average REIT.  But given the dividend advantage of the REITs, they are likely to continue to outperform over the long term…and who doesn’t like the potential for higher dividends?



Should Investors be Cautious?

April 26, 2013


In our last update, we spent some time talking about the “sequester”, which is basically some spending cuts to the Federal Government’s budget that took effect on March 1, 2013.  We concluded that the sequestration cuts, along with the tax increases implemented in January are a prudent step in the right direction and were not likely to be disastrous to the economy.

Hopefully that will prove to be correct, but the employment report from March did take a step backwards.  The employment report, which was released on Friday, April 5th, showed that the “non-farm payrolls” (number of jobs gained or lost) only increased by 88,000 in March, vs. 268,000 in February.   To put this in perspective, we need around 100,000 jobs gained per month in order to keep the unemployment rate steady (currently at 7.6% for March).

We will have to see if the employment numbers can rebound over the next few months, but in the meantime, the stock market is taking it in stride.  This is a delicate balance; the stock market investors would like to see employment improve, but not too fast…why?  Because the Federal Reserve is being very accommodative, meaning that they are doing all they can to keep interest rates very low, which is generally good for businesses and for stocks.  So if the employment picture improves too quickly, then the Fed will have to worry more about inflation and have to start increasing interest rates.

Worst Six Months

Another reason to be cautious over the next few months is that we are about to enter the “worst 6 months” part of the calendar.  We have discussed this in the past, but to review, if you go back to 1950 when the S&P 500 index began, most of the gains in the stock market have come from November to April.  And from May to October the stock market on average has been pretty flat.  Below is a chart from the Stock Traders Almanac which shows how this strategy has fared since 1999:


In the world of investing, nothing is perfect and nothing works every time, but this strategy has a pretty good track record.  In addition, we know that this phenomenon is well known by most investment advisors, and the more that use this idea, the more self-fulfilling it becomes.  It won’t overrule everything else, but it is a factor to consider.