REITs vs. Stocks: Everything You Need to Know

There has been a lot of debate about whether stocks or real estate is a better investment for the long haul. Many investors believe that investing in stocks offers the best return potential over the long term.

However, the data says otherwise.

Here's a closer look at how stocks and real estate investment trusts (REITs) have performed throughout the years.

Key findings

Key findings

• REITs have outperformed stocks on 20-to-50-year horizons as well as in the latest full year of data (2021).
• Most REITs are less volatile than the S&P 500, with some only half as volatile as the market at large.
• The self-storage REIT subgroup shows the highest returns, with annualized returns of 18.8% from 1994 to 2021.
• Infrastructure and data center REITs have outperformed the S&P 500 since Nareit started tracking them in 2012 and 2015.

History

REITs vs. stocks: Digging into the historical data

The U.S. Congress established REITs in 1960 to provide all investors access to income-producing commercial real estate that was once only available to wealthy individuals.

The National Association of Real Estate Investment Trusts (Nareit), which formed that same year, has been keeping track of historical return data for the REIT sector since 1972. It has developed several indexes to track returns, led by the FTSE Nareit All Equity REITs Index. This index contains all 12 equity REIT subsectors (it excludes mortgage REITs, which it classifies as financial companies).

Here's a look at how this index has performed over the years versus the average stock market return (measured using the S&P 500's total returns)

As you can see, REITs have outperformed the S&P 500 over the past 20-, 25-, and 50-year periods. REITs also outperformed stocks in the most recent full year of available data (2021). Stocks have delivered higher returns in recent years, with the S&P 500 beating REITs over the previous five- and 10-year periods.

However, the overall data shows that REITs have outperformed stocks over the long term.

REIT Dividends

Dividends drive much of REIT returns

Dividend payments are meaningful contributors to investment returns for stocks and REITs. For example, since 1930, 40% of the S&P 500's total return has come from dividend income, according to data from Morningstar and Hartford Funds.

Ned Davis Research and Hartford Funds dug deeper into the dividends and returns data. They found that S&P 500 companies that paid a dividend significantly outperformed non-payers since 1973 (9.6% average annual total return vs. 4.8%).

They also discovered that those whose dividend grew performed better than companies with no change in their dividend policies (9.6% vs. 7.1%), while dividend cutters and eliminators delivered the worst returns (negative 0.5%).

Dividends have an even bigger impact on REIT returns because these organizations must distribute 90% of their taxable net income via dividends to investors to remain in compliance with IRS guidelines. About half of REITs’ total returns come from dividends, according to Nareit. 

As noted, dividend growth tends to drive higher returns. That would also help explain the REIT sector's strong long-term performance since many REITs have a long history of increasing dividends.

For example, three REITs qualify as Dividend Aristocrats® , which are S&P 500 members with more than 25 years of consecutive dividend increases. More than a dozen REITs qualify as Dividend Achievers, which are stocks that have delivered more than a decade of steady annual dividend growth.

REIT Volatility

REITs and volatility

Dividend-paying stocks tend to be less volatile than the broader stock market.

One volatility metric is beta, which measures a stock's volatility compared to the S&P 500. The S&P 500's beta is 1.0. A beta of less than 1.0 means a stock is less volatile than the broader market, while a beta above 1.0 means a stock is more volatile than the S&P 500.

According to the same data from Hartford Funds and Ned Davis Research, dividend payers had a lower beta (0.94) than the S&P 500 and non-payers (1.18). Meanwhile, dividend growers had an even lower beta, at 0.88, meaning they're even less volatile.

Given that data, it's no surprise that most REITs have a lower beta than the S&P 500. Of the 18 REITs in the S&P 500 as of late 2022, 17 had betas of less than 1.0, with many having considerably lower betas.

For example, Realty Income (NYSE:O) and Public Storage (NYSE:PSA) each have a beta of 0.5 or less. A beta of 0.5 or less implies these REITs are half as volatile as the S&P 500. So if the S&P 500 slumps 10%, these REITs should only decline in value by 5%.

Because of their lower volatility, REIT returns are less correlated to the stock market. That makes REITs an excellent way for investors to build a diversified portfolio and improve their risk and return profile.

Performance of REIT Subgroups

Which REIT subgroups have done the best at outperforming stocks?

A closer look at REIT data shows that some subgroups stand out for their outperformance versus the S&P 500. Nareit has been tracking this data since 1994 for most property sectors (timber, infrastructure, data centers, and specialty are newer entrants to the REIT sector and thus only have a few years of tracking data).

Here's a look at how the various subgroups have performed versus the S&P 500:

As the table shows, several major REIT subgroups have outpaced the S&P 500 since Nareit began tracking these results in 1994.

Leading the pack has been self-storage REITs, which have outperformed all other subgroups by a wide margin since 1994. They delivered a jaw-dropping performance in 2021, with total returns of almost 80%.

Driving the subsector's longer-term outperformance is that self-storage properties tend to have low construction and operating costs, making most units profitable at low occupancy rates. On top of that, most leases are month-to-month, enabling self-storage owners to increase prices more quickly to reflect current market rates.

As an asset class, self-storage properties have delivered the highest net operating income (NOI) compound growth rate (4.8%) compared to other property types, including industrial (2.3%), multi-family (2.4%), and office (1.6%) since 2000.

Another standout REIT subsector has been industrial REITs. Driving the subsector's strong results, especially more recently, has been the rise in e-commerce.

With more people shopping online, industrial REITs, especially those focused on logistics properties, have expanded rapidly by developing new distribution centers to support this growth. Robust demand for warehouse space coming out of the pandemic has allowed REITs to capture significantly higher rental rates as leases expire and renew at current market rents.

Residential REITs have also performed well over the years. This subgroup -- which includes multi-family, single-family home rentals, and manufactured homes -- benefits from fairly recession-resilient demand and rents that expand at market rates each year. One factor behind rent growth is the lack of affordable single-family homes, which causes more people to continue renting.

As noted above, Nareit has added four property types to its tracking in recent years. Here's how these newer subsectors have performed versus stocks since their inception:

As the table shows, data center REITs and infrastructure REITs have outpaced the broader stock market since Nareit started tracking these new property classes. Powering their strong returns is robust demand for communications and data storage infrastructure solutions as demand for data grows.

Drivers have included upgrades to faster mobile networks (4G and now 5G), streaming, and digital transformation initiatives by companies to bring more of their business processes online. That's enabled REITs focused on communications infrastructure, such as cell towers, to build more sites and add additional tenants to each tower, while data center operators have expanded their capacity.

These expansions have powered above-average growth in their funds from operations (FFO) per share.

This digital transformation trend has also driven significant consolidation in the data center REIT sector as other REITs and private equity firms increase their scale and build out platforms. This merger and acquisition activity has left only two remaining players: Equinix (NASDAQ:EQIX) and Digital Realty (NYSE:DLR).

It's worth pointing out that while the other two newer REIT subgroups aren't beating the S&P 500 since Nareit started tracking them, they've still performed well overall.

Related REIT topics

REITs vs. Stock Market

Which REITs stand out versus the stock market?

While REITs as an overall group have outperformed stocks -- and certain subgroups have done even better during most periods -- many individual REITs stand out as consistent long-term outperformers.

For example, the sector leader in the past decade was self-storage REIT Extra Space Storage (NYSE:EXR), with an overall total return of 629.8%, or 22% annualized (through Sept. 30, 2022). Extra Space has nearly doubled the return of its closest peer. The company benefited from the above-average NOI growth in the self-storage space, acquisitions, and expanding its sector-leading third-party management platform.

Another standout REIT performer has been leading industrial REIT Prologis (NYSE:PLD). The company has vastly outpaced the S&P 500's total return during the past three-, five-, and 10-year periods, as well as since its formation in 1998.

One factor driving its more recent outperformance has been superior growth in its core FFO and dividend versus the S&P 500, its logistics peers, and the REIT sector average:

Another headliner for long-term outperformance has been Realty Income. The retail REIT, which focuses on owning freestanding net-lease properties, has produced a 14.4% compound average annual total return since its initial public offering in 1994.

One factor contributing to those market-crushing total annualized returns has been the REIT's steadily rising dividend. Realty Income -- which pays a monthly dividend -- has increased its payout for 100 straight quarters, qualifying it as a Dividend Aristocrat. Realty Income has boosted its dividend at a 4.4% compound annual rate since 1994.

The data on REITs is clear

The U.S. Congress created REITs to level the playing field so that all investors could access income-producing, wealth-creating real estate. That has turned out to be a boon for the average investor because REITs have outperformed stocks over the long term -- thanks partly to their dividends -- with less volatility.

Many subsectors and specific REITs have delivered even higher returns. Because of all that, investors should strongly consider adding REITs to their portfolios by either investing in a REIT ETF or purchasing shares of specific REITs.

Sources

• Barwick, John (2022). Nareit. "REITs Support Completion Portfolios with Increased Returns and Lower Volatility."
• Extra Space Storage (2022). "Company Presentation, November 2022."
• Hartford Funds (2022). "The Power of Dividends: Past, Present, and Future."
• Nareit (2022). "REITs and Dividend Income."
• Nareit (2022). "Why Invest in Real Estate Investment Trusts (REITs)?"
• Prologis (2022). "Fact Sheet."
• Realty Income (2022). "Investor Presentation, November 2022."
• Sun Communitie (2022). "Investor Presentation, May 11, 2022."