WASHINGTON, DC—“The income-oriented portfolio provides slightly less annual total return, but a greater income return,’ according to a new study conducted by Santa Monica, CA-based Wilshire Funds Management and sponsored by NAREIT. “For many retirees this may be the appropriate trade-off.” Furthermore, the study says, adding REITs to a retirement portfolio is “critical to achieving the goal of generating a stable income with a reasonable level of risk tolerance.”
Using 40 years of investment return data through 2015, the study shows that adding a range of high income-generating assets—including REITs as well as preferred stocks and other vehicles—to a traditional retirement-stage portfolio could boost income returns by nearly 40%, while providing comparable total returns and no increase in risk. The research is based on a variation of the Mean-Variance Optimization method for portfolio modeling, incorporating a requirement for a specified level of income return.
Wilshire found that a traditional MVO-modeled portfolio that delivered a 2.37% annual income return and a 5.37% annual total return with an 8% level of portfolio risk could be enhanced with IOMVO modelling. The latter delivers an annual income return of 3.25% and a comparable 5.27% annual total return with the same 8% level of risk.
The Wilshire study says that for essentially all investors saving and investing for retirement, investing in both real estate equity and debt through stock exchange-listed REITs is “the simplest, most liquid and lowest cost strategy for accessing the real estate asset class. For real estate equity investment, historical data reveal that investment returns of listed equity REITs have outpaced the returns on otherwise similar properties owned directly or through unlisted funds.”
Additionally, the study notes that directly owned real estate is “extraordinarily illiquid,” and investments in individual assets are typically very large relative to the total value of the investment portfolios of most individual investors. For these reasons, the study includes only two forms of real estate investment in the opportunity set of its analysis of income-oriented retirement portfolios: listed equity REITs and listed mortgage REITs.
Over the past 40 years, the study says, “listed equity REITs delivered total returns averaging 13.75% per year, higher than all other investments” considered in the study. “The robust total returns suggest that listed equity REITs can help retirees protect themselves from depletion risk.”
Monthly total returns of listed equity REITs over the 40-year period were relatively volatile at 16.99%. At the same time, according to the Wilshire study, equity REIT returns had relatively low correlations with US common stocks, investment-quality bonds, high-yield bonds, non-US common stocks, preferred stocks and commodities, “indicating that they play an important role in portfolio diversification which reduces portfolio volatility. Equity REITs have the highest share of total return derived from income of any equity considered other than preferred stocks and mortgage REITs.”
The key attribute of mortgage REITs as far as retirees are concerned, according to the study, is their steady current income. “As with preferred stock, mortgage REITs can be viewed as an investment that converts portfolio capital value into monthly income,” Wilshire says. “The income return from mortgage REITs has historically been greater than the total return for the past 40 years, with an average income returns of 12.35% per year and average price appreciation of -4.81% per year.”
Joshua Emanuel, CIO at Wilshire, notes that an investment strategy that generates income is “critical for many retirees. Depending on the income needs of the investor, portfolios that generate less income may require retirees to dig deeper and more frequently into their savings to fund their expenses, potentially resulting in the depletion of their assets while they are still living. Income-oriented portfolios with significant allocations to assets like REITs, high-yield bonds, preferred stocks and non-US developed stocks may help investors meet the challenge of producing retirement income with less reliance on their savings.”
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