Learn how the upcoming Real Estate Investment Tusts (REITs) stack up against good old, Foolish index-trackers.
More precisely: Real Estate Investment Trusts (REITs) versus stock-market index-trackers. I'm not going to look at the short-term outlook for the property and shares markets, because that is not Foolish. In the short-term, anything can happen. When a Fool invests, he/she does so with a long-term view.
Index-trackers are Foolish things that have been proven over time, so I'm going to concentrate on seeing if REITs match up to them. But first, an outline of index-trackers for those of you who are new to this. Index-trackers are funds that buy all the shares in a particular index, such as the FTSE All-Share or the FTSE 100. Your investment will then track the market. They are very cheap, and over a long period they've been shown to outperform actively-managed funds more than 80% of the time. You can learn more in our guide to index trackers.
If all goes well, REITs will be available from January 2007. These invest in property, so you can expect their value to go up as the porfolio's property prices rise and go down when they fall. You can already invest in property companies, although the advantage of REITs is that companies which convert to trust status won't pay corporation tax. Just like index-trackers, REITs should be available in ISAs too, which will shelter your investment from personal taxes.
Unlike trackers, REITs are managed, so you're relying on the property buying and portfolio management skills of the trust managers. Being managed, this doesn't sit well with an old Fool like me, as us stupid humans don't seem to fare well against the collective strength of markets (see Index Trackers vs Managed Fund?). Also, let's not forget that they'll probably cost a lot more in charges as well.
But all things aren't equal. Perhaps the property market will fare better than the shares market in the long-term. This being the case, REITs may be a good way to invest on a budget in property, and without the hassle of becoming a landlord. There's another major difference between buy-to-let and investment in REITs. The majority of successful residential landlords will admit that they are in the game for the capital gains (the profits when they sell up), not for the rental income, which often falls short of their costs for the first five, ten or even fifteen years.
However, judging by comments from countries that have had REITs for some time, (such as from fellow writers on our US website), the rental income (which is payable to you as a dividend) is likely to be more important in REITs than in buy-to-let. It'll also be even more important than the valuable dividend you get in index-trackers. This could mean that when real-estate investment companies convert to REITs in January, the focus may shift from capital gains (property price increases) to income. This makes REITs a different kind of investment from both buy-to-let and index-trackers, which are - usually - about long-term capital growth.
That said, property markets, like share markets, can expect long-term growth too. Both markets seem to respond in the same way to rapid interest-rate rises (i.e. people sell), despite some commentators seeing REITs as a way to hedge against inflation. With the world economy expected to grow over the next forty years, it looks good for both property and shares.
Another aspect to consider is diversification. If you have an index-tracker you could argue that you're diversified enough and that too much diversity means you have no chance of outperforming anything. Homeowners in particular may already consider themselves to have enough invested in property. It's hard to go wrong with a good old, reliable tracker, but non-homeowners may consider getting some exposure to property too.
A combination of both index trackers and REITs would give you not just diversification in shares, but also in property, as you're not tied to a limited portfolio like most landlords. In that regard, you could consider REITs to be the closest thing property has to index-trackers.
So it seems the question 'REITs vs. index-trackers?' may actually translate as 'income vs. long-term growth?' Others may prefer to express it as the equation: index-trackers + REITs = diversification.
> Take a look at this upbeat review of REITs.
> See some low cost, stupid-human beating index-tracking ISAs.