REITs offer a diverse investment option in a volatile market

Even in a turbulent stock market, real estate investment trusts (REITs) can offer a smart way to diversify your portfolio, says Patricia McGowan, partner and chair of the Baltimore Corporate Group at Venable, LLP.

“People are looking for ways to diversify out of the stock market, and REITs can offer more stability and less volatility than other stocks,” said McGowan. Despite expectations around interest rates and recession, “A lot of REITs have strong balance sheets and are well-managed, so they will feel the downturn, but not as strongly as other sectors, like technology.”

McGowan focuses her practice on a wide range of corporate law matters, and her interest and expertise in REITs stems from the fact that so many REITs are formed in Maryland.

In 1962, Maryland became the first state to pass legislation allowing for the formation of REITs, just two years after the federal government did the same. This gave Maryland an edge in attracting new REITs, and over time the state has developed a sophisticated legislative framework to govern their operation.

Now, hundreds of REITs have been formed under Maryland law, and the vast majority of REITs traded on the New York Stock Exchange are based in Maryland.

Within the REIT market, there are literally dozens of segments that investors could consider. REITs can be made up of any type of income-producing property, from residential to commercial, and investors can narrow on certain industries or geographies when selecting a REIT. McGowan recommended looking at the strength of the sector.

“Industrial sectors are strong, as well as data centers,” she said. “Hotels are coming back post-pandemic as travel is up. Life sciences are strong, as are infrastructure — such as cell towers, energy pipelines and energy assets.”

With the rise of remote and hybrid work, REITs within the office space sector are facing challenges, but McGowan predicts that these businesses will adapt.

“We will likely see changes in office spaces that will require investment. Perhaps the spaces will be repurposed or updated to appeal to the changing workforce. Some companies will make this transition, and others will not,” she said. For now, investors will have to wait and see.

REITs can provide an interesting window into the changing economy. For instance, some more specialized REITs are forming around green technologies, such as wind farms, solar farms and electric car charging stations. McGowan said that federal investment in green infrastructure projects could lead to more growth in this area.

“There has also been a surge in single-family housing REITs,” said McGowan. “Many millennials are choosing to rent rather than buy in stable neighborhoods, and this is driving up the market for those properties.”

For investors concerned about liquidity, McGowan said, publicly traded REITs are just as liquid as any stock. Private REITs will allow for redemptions but may have caps because they are designed to be a longer-term investment. However, many REITs pay dividends to investors, which can be attractive, and REITs are a way for smaller and individual investors to get the benefit of larger-scale real estate investment.

Despite recent changes to SEC rules that require REITs to disclose risks related to climate change, investors should not be concerned, McGowan said.

“Climate change is a financial risk, and many REITs are already making great strides in mitigating their exposure. Profitability requires efficiency, so a lot of REITs are already investing in energy-efficient buildings and green technologies. It is a great story for them to tell.”

While rising interest rates and inflation affect many portfolios, REITs can offer a more stable investment option that is not as vulnerable to changes in the economy, she said. They allow investment in real estate at scale, which dampens the impact of market fluctuations. Overall, McGowan said, REITs play a much larger role in the economy than many people realize.

“They make large-scale real estate investment accessible to the average person.”