And the Winner Is….

Chidem Kurdas

If you paid any attention to financial news headlines, you are aware that in 2014 the American stock market broke records, bonds did much better than forecast and institutions crowded into certain private equity and hedge funds.

But as it turns out, the fairest of them all was not corporate equities, fixed income instruments or alternative investments. No.

As far as I can tell, the best performing asset class in the year past was real estate investment trusts. REITs returned over 30%. That’s more than double the return on large-cap U.S. stocks, the next best performer.

Hedge funds made only a little over 4%, as estimated by BarclayHedge on the basis of a small number of funds that reported their December return to the database. Most funds have not yet reported and the estimate may change, but it is unlikely to change so drastically as to make it to the top tiers of the asset class ranking.

Did anyone predict a year ago that REITs were the best place to put your money? Well, people must’ve since there is a lot of money in these investment vehicles. REITs trading on the New York Stock Exchange had a market cap of $880 billion as of September 2014, but that’s just a subset of listed REITs and then there is the unlisted variety. Exchange-listed REITs owned $1.7 trillion in gross assets.

The last time I noticed REITs being widely pitched as your best bet was in 2006. That year I distinctly remember watching PowerPoint presentations showing the advantages of REITs. My memory may be colored by what followed, namely the property slump and associated credit crunch. In the next two years REITs generated large quantities of red ink. Then they recovered in 2009-2010.

Why did REITs outperform other assets in 2014? The obvious explanation is low interest rates. Historically low rates – and Federal Reserve policies that have kept them low – affected just about all assets. But REITs may be more sensitive than other assets to interest rates, accounting for the stellar performance compared to other classes.

However, if REITs benefit from low rates more than other assets do, they will also be more adversely affected when rates rise. Even so, there is a strong long-term case for making REITs part of a diversified portfolio. Leaving aside 2007-2008, they’ve been a reliable investment in the past decade and more.

Have REITS gone too high? There was a real estate boom-and-bust just recently. In the past markets did not repeat bubbles in the same asset class until generations passed and the experience faded from memory. But cycles may be different now because the Federal Reserve and Federal government policies are driving financial markets.

Still, it is hard to believe that the wide variety of properties and mortgages REITs invest in are overpriced. Specialized REITs offer exposure to any type of property, ranging from nursing homes to retail to apartment and office buildings to storage facilities.

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