A problem Real Estate Investment Trusts (REITs) face more than other investment vehicles is investor preference. Most investors see REITs as a diversification tool, an interest rate hedge, or a dividend stream. Equity REITs and Mortgage REITs meet a clear need for all three of these requirements. This is evident in the increased number of Equity and Mortgage REITs available, as well as their overall market capitalization.
Investors, who need interest rate exposure or hedges, are always better off choosing a Mortgage REIT because they get the best risk return scenario. Similarly, investors looking for exposure to the broader real estate market or the strongest dividend flow will do best with Equity REITs. Equity REITs have consistently been the best performing total return group over the past 25 years, while Mortgage REITs have been the best performing dividend yield group.[1]
Investors tend to lump all REITs into one bucket. Hybrid REITs have not proved to be any less risky than pure Equity REITs or Mortgage REITs. Additionally, they have yielded inferior returns when compared to both Mortgage REITs and Equity REITs. Furthermore, they don't offer investors any benefits they could not get by simply buying a Mortgage REIT and an Equity REIT.
In general the market tends to punish diversification as well. Investors prefer to diversify their own portfolios with companies that specialize in a certain industry. This is also the case with Hybrid REITs. Currently the universe of REITs is very small compared to the greater equity market, making it very easy for investors to diversify their portfolios with a handful of different REITs. In effect this punishes Hybrid REITs because investors are less willing to invest in a diversified company.
Conclusion: Hybrid Real Estate Investment Trusts Provide No Benefit to Most Investors
Hybrid REITs prove to be an inferior investment alternative, even under the premise of real estate diversifier. The problem lies in the differences between Equity REITs and Mortgage REITs. These investment vehicles have different drivers, which could be correlated at times and uncorrelated at others. Additionally, the overlapping exposure to interest rates negates the additional exposure Mortgage REIT investors might get to the broader real estate market. This might also suggest that investors should avoid holding both Mortgage and Equity REITs. Investors looking for interest rate exposure are better off holding Mortgage REITs, while investors looking for exposure to the broad real estate market are better off holding Equity REITs. Holding both simply increases the overall risk of a portfolio, without providing enough return to compensate.
[1] National Association of Real Estate Investment Trust Data from 1981-2006; www.nareit.com
