Four reasons to consider investing in US real estate

Key takeaways
Diversification
Real estate typically doesn’t behave the same as stocks and bonds, so it can help diversify an investment portfolio.
Income and inflation protection
A real estate investment trust (REIT) must pay out 90% of its income, which has historically kept up with inflation.
Tax advantages
A REIT can pay out ordinary income, capital gains, or return of capital, and each are taxed differently.
Is owning a home your only investment in real estate? If you don’t have REITs or other real estate investments in your portfolio, consider this: Savvy institutional investors, like pension funds, foundations, and insurance companies, have historically had from 6%-12% of their portfolios in real estate — compared to 2% for individual investors.1 Of course, individual investors and institutions have different investing needs, goals, risk profiles, and time horizons, but this does support the merits of real estate investments.
A typical way to invest in real estate, aside from owning property, is via buying shares in a real estate investment trust (REIT), which is a company that owns (and typically operates) income-producing real estate or real estate-related assets across multiple commercial properties, sectors, and regions. A REIT is either publicly traded on an exchange or a private offering, which is typically available through a financial professional.
Here are four reasons to consider an allocation to real estate:
1. Diversification
A key investing rule of thumb is diversification — allocating your investments among different types or asset classes, typically stocks, bonds, and short-term investments like cash. The idea is that they won’t all move in the same direction at the same time. Real estate typically doesn’t behave the same as stocks and bonds, so it can help diversify an investment portfolio.
2. Inflation protection
Income from real estate investments has historically kept up with inflation. The ability to raise rents when inflation rises is one reason. Another is that many real estate investments have rental contracts with inflation-based increases. As shown below, real estate income (represented by net operating income or NOI growth) has outpaced inflation (represented by the Consumer Price Index) over the past 29 years. (To show this on a similar scale, the index level was normalized at 100 in 1994.)
Source: Green Street Advisors, Bureau of Labor Statistics as of December 31, 2022. Net operating income (NOI) growth is the average NOI growth by year across the major property sectors in North America: apartment, industrial, mall, office, and strip retail. NOI growth equals all revenue from a property minus all reasonably necessary operating expenses. NOI growth may not be correlated to or continue to keep pace with inflation. Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a representative basket of goods and services.
3. Income potential
For investors seeking income, an allocation to real estate can make sense. A REIT is required to distribute 90% of its taxable income to shareowners. Also, US private real estate — which individual investors can access through certain private REITs — has historically offered higher income compared to US bonds (fixed income) and stocks (equities).
Source: Morningstar Direct. US private real estate is represented by NCREIF Property Index; US equity is represented by S&P 500 Index; US fixed income is represented by Bloomberg US Aggregate Bond Index. 20-year average income return is as of December 31, 2022. You cannot invest directly in an index. Past performance is not indicative of future results. There is no guarantee that any trends shown herein will continue.
4. Tax advantages
Investing in US real estate may provide tax benefits. For example, REITs can pay three types of distributions: ordinary income, capital gains, or return of capital (ROC). Each is taxed at a different rate. Ordinary income is taxed at your marginal income tax rate. Capital gains are taxed at either 15% or 20% depending on your tax bracket. ROC distributions are tax deferred until you sell your REIT shares. For estate planning purposes, an inheritor of a REIT receives a step up in cost basis to fair market value..2
Footnotes
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1
There are material differences in the investment goals, liquidity needs, and investment horizons of individual and institutional investors. Investors should consult with a financial professional regarding their own situation and risk tolerance before making any investment decisions. Retail investors may already have significant exposure to the real estate asset class through home ownership. Individual investor based on retail investments in real estate asset class from McKinsey Global Growth Cube data, full year 2021, most recent data available. Institutional investor based on 2021 Institutional Real Estate Allocations Monitor by Hodes Weill & Associates and Cornell Baker Program in Real Estate. Survey participants number 224 institutional investors from 37 countries with more than $13.4 trillion USD in total assets and $1.2 trillion USD in real estate assets.
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2
A step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance. The asset receives a step-up in basis so that the beneficiary’s capital gains tax is minimized. A step-up in basis is applied to the cost basis of property transferred at death.