Average annual returns in long-term real estate investing vary by the area of concentration in the sector. Average 20-year returns in the commercial real estate slightly outperform the S&P 500 Index, running at around 9.5%. Residential and diversified real estate investments do a bit better, averaging 10.6%. Real estate investment trusts (REITS) perform best, with an average annual return of 11.8%.
S&P 500 Index
The S&P 500 Index's average annual return over the past 20 years is approximately 8.6%. By any measurement, the real estate sector has outperformed the overall market, even factoring in the drastic collapse in housing prices during the 2008 financial crisis.
The real estate sector is divided into two main categories: residential and commercial real estate. Within either category, there are vast and varied opportunities for investors, such as raw land, individual homes, apartment buildings, and large commercial office buildings or shopping complexes. Investors can choose to invest directly in residential or commercial real estate or invest in real estate company stocks or bonds. There are also mutual funds and exchange-traded funds (ETFs) available that track the real estate sector.
One way investors can easily obtain diversification in real estate investments is through investing in one of the best-performing real estate investment instruments, REITS. REITS are securities that trade on an exchange, just like regular stocks. REITs may be invested in properties, real estate or property management companies, mortgages, or any combination of these. They are specially regulated and offer tax benefits and investment advantages, such as dividend reinvestment plans. REITs have established a reputation for offering investors liquidity, diversification and good overall investment returns.
Investors can invest directly by buying shares of REITs or obtain access to them through real estate sector mutual funds or ETFs that have major portfolio holdings of REITs.
Mark Struthers, CFA, CFP®
Sona Financial, LLC, Minneapolis, MN
While it can certainly be part of a portfolio, the returns of actually owning real estate may not be quite what you think. With your primary home, in most cases, you will be lucky to keep pace with inflation, research shows. I would offer a word of caution. We have been in a low rate environment for a long time. Real estate often pays a high dividend. If the return came from higher than normal cash flow, if rates were to rise, the value may fall.
Investing in REITs is a great way to gain exposure to real estate, just know what you’re buying. Private placement REITs are layered with fees and conflicts of interest. Understand what you are buying with publicly-traded REITs too. For example, do they own a lot of mall properties that are going through a secular change as more people shop online.