Stocks are the best investment in a bull market, but they are often associated with at least some degree of uncertainty, since it’s difficult to predict when a rally might end and the high volatility will erase the gains. Bonds are much less risky, but also generate substantially lower returns. One asset class that is known to provide stable returns over the long run is real estate. People need housing and they are paying rent, thus providing the owner of the rented property with a stable cash flow.
However, holding physical properties can cumbersome and transactions involving real estate are plagued by bureaucracy, paper work and even fraud. On the other hand, investors can easily buy shares of real estate investment trusts. REITs give investors the opportunity to get some exposure to real estate, without actually owning any properties. Investors in REITs get the opportunity to get some benefits from a growth registered by the stock over the long run and also enjoy regular and substantial dividend payouts, since REITs are required to pay most of their profits to investors.
Currently, there are many concerned voices on the Street, saying that the interest rates hikes that Fed is planning this year, will hurt REITs. For one, higher rates, will increase their borrowing costs, thus reducing their profits. In addition, alongside higher interest rates, bond yields will also go up, which will draw more investors away from REITs. However, the yield of many REITs is much higher than the 10-year Treasury, which makes them more appealing.
In addition, while the Fed raising rates will affect REITs’ costs, the economy is strong and the rates suggest further strengthening. A stronger economy, means people have more income and companies are also growing, which increases demand for housing and commercial real estate.
There is another very good reason why investing in REITs this year is a good idea: the recent tax reform. Under the Tax Cuts and Jobs Act, REITs are classified as “pass-through” investments, which lowers the taxes on dividends from REITs. In addition, REITs will be able to enjoy some deductions, such as a 20% deduction on pass-through entity income.
In this way, REITs should be a part of a diversified portfolio, but the question is which REITs to choose, since not all of them are focusing on housing or office real estate, but on a variety of other industries, such as data centers, warehouses, industrial facilities, etc. Here’s where our research can come in handy. At Insider Monkey, we follow over 650 hedge funds and analyze their quarterly 13F filings and assess the hedge fund sentiment towards thousands of stock. We use this data to identify the best stocks in the small-cap space that the best-performing hedge funds are invested in. These stocks are part of our small-cap strategy, which has outperformed the market by more than 20 percentage points in the last four year, and we share these stocks in our quarterly newsletters. In addition, we monitor around 140 activist hedge funds and cover one of them every month and determine the best way to imitate that hedge fund (see more details).
When it comes to REITs, they are far from being hedge funds’ most popular choices, but, nevertheless, many hedge funds are invested in REITs. Interestingly enough, most popular REITs among hedge funds in our database are not those focused on housing and it looks like dividend yield is not the most important metric that hedge funds are focused on. There is one particular type of REITs that has attracted the most attention from hedge funds, as you can see on the next page, where we will discuss five most popular REITs, which also saw an increase in the number of bullish investors during the last year.