Ben Felix - Real Estate Investment Trusts (REITs)

Short Summary

Main recommendation: Don't overweight REITs in a portfolio of index funds; if you already hold a total market equity ETF, you already have roughly 3 to 5% exposure to real estate, and the research suggests the factor exposure REITs provide can be captured more efficiently through small-value stocks and lower-credit bonds. Ben Felix argues REITs are not a truly distinct asset class, since their returns are explained by stock and bond risk factors, while their sector-specific risk carries no expected premium.

Key Points

• REITs are tradeable funds holding income-producing real estate, offering liquidity and diversification without direct property management, and low-cost REIT index funds exist.
• Mladina (2018) found that the factor exposure of real estate roughly resembles that of a portfolio consisting of 60% small-value stocks and 40% high-yield bonds.
• Real estate's core risk is idiosyncratic sector risk, which is not a priced risk and carries no expected positive return.
• No real estate index earned a place on the efficient frontier in Mladina's study; the five-factor benchmark dominated them.
• Kizer and Grover (2017) matched REIT factor exposure with 67% small-value stocks and 33% corporate bonds, which historically produced better returns and risk-adjusted returns than REITs over their study period.
• REITs are tax inefficient: most income is taxed as income in taxable accounts, and foreign withholding tax applies to US and foreign REIT income even in tax-free accounts.

Details Worth Noting

• Concrete instructions: Keep REIT exposure close to market cap weight rather than overweighting it, since your total market equity ETF already holds about 3 to 5% real estate. If you want the factor exposure behind REITs, add small-value stock exposure and lower-credit (global) bond exposure instead. For US equities, the video names IJS and VBR as US-listed small-value ETFs. In Canada, the video notes that VBG and VBU together offer global bond exposure hedged to Canadian dollars, which gives more credit premium exposure than a Canadian corporate bond ETF. Adding small-value exposure internationally is harder, as the speaker notes.
• Performance context: From July 1989 to June 2019, the S&P Global REIT Index returned 9.24% per year versus 7.77% for the MSCI All Country World Index (both gross dividends, in Canadian dollars), with a correlation of 0.513.
• Canadian REIT options are limited: Vanguard's FTSE Canadian Capped REIT Index ETF has 18 holdings and a 0.39% MER; BMO's Equal Weight REITs Index has 22 holdings and 0.61%; iShares S&P/TSX Capped REIT Index ETF has 19 holdings and 0.61%.
• The Mladina study covered January 1986 to December 2015, using a modified Fama-French model with market beta, size, value, term, and default factors; Kizer and Grover (2017) used market beta, size, value, momentum, term, and credit factors.

Bottom Line

REITs have historically performed well, but the evidence suggests they add uncompensated sector risk and tax drag, so the efficient way to pursue their factor exposure is through stock and bond funds rather than extra REIT allocation.