How much real estate should you have in a balanced portfolio?


When investors talk about income-producing assets, the first that come to mind are dividends and interest, with capital gains a close third. But what about investment real estate? If you hold an asset allocation ETF, it will be chock full of stocks and bonds but offer little real estate exposure apart from a few publicly traded real estate firms. 

How much should real estate comprise in a balanced portfolio? While a principal residence certainly will be a big part of most people’s net worth, personally I don’t “count” it as part of my investment portfolio even though it can ultimately serve as a retirement asset of last resort, via home equity lines of credit (HELOCs), reverse mortgages or simply an outright sale when it’s time to enter a retirement or nursing home. If you take that approach, and many of my advisor sources do, then the question becomes how much real estate should you have in your investment portfolio, above and beyond the roof over your head? 

With Canadian housing prices soaring since the pandemic, those fortunate enough to have investment real estate may well be overweight the asset class. You often see this in Ask MoneySense questions from couples approaching retirement, and in the financial profiles published by major Canadian newspapers. Often, they own two or three investment properties above and beyond the house they live in, but little in the way of financial assets. 

Certainly, if you are happy being a landlord and handy about home maintenance, direct ownership of rental apartments, duplexes or triplexes and the like is a time-honoured route to building wealth. That’s the focus of organizations like the Real Estate Investment Network (REIN). 

However, if you don’t want the hassle of being a landlord, you may want to try real estate investment trusts (REITs), which are far more diversified both geographically and by housing type. Some REITs focus on baskets in particular real estate sectors, such as residential apartments or retirement homes. 

A still more diversified approach is to buy ETFs providing exposure to multiple major REIT categories, whether Canadian, U.S. or international. 

In Unconventional Success, David Swensen—famously in charge of asset allocation for Yale University—advocated a fair chunk to real estate. In a “well-diversified, equity-oriented” portfolio of 70% equities to 30% fixed income, Swensen allocates 14% of the total portfolio to real estate or REITs, which works out to 20% of the equity allocation. Swensen describes REITs as a hybrid between equities and fixed income, with inflation protection.

But the question arises: how safe will REITs or REIT ETFs be in the post-COVID world?

To the extent REITs are not too highly correlated to stocks, they certainly help diversify. Some advisors suggest 10% to 20% of a total portfolio can be devoted to REITs or ETFs holding REITs. They tend to distribute a high percentage of their income, much of it taxable, so you may wish to hold them primarily in registered portfolios like TFSAs (ideal!), or RRSPs, or RRIFs.

Since COVID hit, REITs have not been for the faint of heart—particularly REITs highly exposed to commercial real estate. After the initial and subsequent lockdowns, many workers discovered the joys of working from home (see this post on WFH stocks), and many REITs have come down in value since the COVID bear market of March 2020. Of course, if you believe the worst is over and the beginning of an era in which COVID vaccines become widely available is at hand, then this might be the proverbial buying opportunity. 

Whether or not REITs are appropriate investments in a post-COVID recovery world depends on several factors, says financial planner Matthew Ardrey, wealth advisor with Toronto-based TriDelta Financial. 

First, it depends on what type of real estate the REIT primarily invested in. “I would argue a REIT invested in a diversified portfolio of residential apartment buildings has a much better chance of holding its value than one whose primary investments are in retail shopping centres.” 

Residential apartments have had excellent payments rates with little to no defaults through the COVID crisis. “Granted, there was government support for this, but one of the last things people are going to give up is shelter for themselves and their families.”

On the flip side are retail centres, where many stores have closed during COVID; it remains to be seen whether shoppers return in force once the pandemic is truly over. It’s possible the online shopping habit that accelerated in the pandemic and the convenience of shopping online with home delivery may overtake many bricks-and-mortar locations, Ardrey says. “So some of the stores which survived COVID still may ultimately be a casualty of it.”

Real estate has always been about location, and this comes into play when reviewing commercial REITs. “Having prime locations in a large city is an advantage, as one of the factors that attracted the tenants that rent there in the first place is the convenience and perhaps even status of the address. Many companies will be returning to office environments once the crisis has passed.”

A third consideration is specialty REITs, and the time for them may have arrived, Ardrey suggests. Some focus solely on the industrial market, and others on niches, like automotive dealerships. Outside Canada, you can find more specialized REITs, such as U.S.-traded 5G Tower plays like Crown Castle and American Tower.

Adrian Mastracci, portfolio manager with Vancouver-based Lycos Wealth Management, says the REIT idea “makes sense,” but suggests they should not make up more than 5% or 10% of an investor’s total wealth, or not more than 7% of an equity portfolio. “I consider it part of the equity bucket. Publicly traded REITS trade more like equities than real estate.” He advises buying top-quality REITs (or ETFs holding them), diversified across Canada. But he avoids foreign ETFs because “you want the dividends taxed as Canadian dividends.”    

Toronto-based investment coach Aman Raina of Sage Advisors says: “At first glance, with interest rates remaining near zero for the foreseeable future, this should be conducive to higher valuations; however, beneath lie some risks.” On the commercial side, with respect to office space, “there are just too many unknowns with regard to how companies will approach and/or embrace the return of employees back to the office. Many are now re-evaluating their existing footprints with the intent to reduce space. Then there are many capital costs that could be considered to fit up space to be more conducive to health and safety (such as ventilation).

Another unknown is retail properties: “We’ve seen how successful online retail has been during the pandemic. Pre-COVID, there was a consensus that retail space was oversaturated. We could see an acceleration in consolidation of retail space, or repurposing into other uses that may not carry higher rates.” That said, the pivot to more digital forms of commerce will create greater need for space to store data centres and with that some interesting opportunities, Raina adds.

Most of the major ETF suppliers with a Canadian presence have broad-based, passively managed REITs, although there is at least one actively managed offering. 

The Vanguard FTSE Canadian Capped REIT Index ETF (ticker VRE/TSX) was launched in 2012 and has a modest MER of 0.39%. As the name implies, any one holding is capped at 25% of the total portfolio (typically, this is RioCan). Its mix is 22% retail REITs, 19.8% office REITs, 18.5% real estate services, 18.5% residential REITs, 8.5% industrial REITs, 8.1% diversified REITs and 4.6% real estate holding and development. 

An alternative is XRE, the iShares S&P/TSX Capped REIT Index ETF, launched in 2020, which holds roughly 16 Canadian REITs, with weightings almost identical to VRE. The iShares product (from BlackRock Canada) has a slightly higher MER of 0.61%.

A strong believer in apartment rentals could plump for Canadian Apartment Properties REIT (CAR.UN/TSX), a high-quality growth-oriented REIT with half its apartments and townhouses in Ontario. This has been pricey at times, so you may want to wait for a correction, or merely settle for the weighting it makes up in a broader-based REIT ETF. 

Note that while VRE and XRE are both market-weighted, there is an equal-weighted equivalent: the BMO Equal Weight REITs Index ETF (ZRE). Most of its holdings are, as the fund name suggests, equally weighted positions of 5% or 6% per holding. Compared to VRE or XRE, ZRE has relatively more exposure to industrial REITs (12.4% versus 5.23%) but less in residential REITs (16.7% versus 25.72%).  

With the pandemic, some believe the argument has increased for using actively managed REIT ETFs rather than traditional passively managed products like the ones mentioned above. That’s the approach taken by CI First Asset Canadian REIT Income Fund (RIT), which invests in REIT stocks as well as real estate operating corporations and real-estate-related services. 

Finally, those wanting exposure outside Canada might consider something like the Vanguard Real Estate ETF (VNQ/NYSE ARCA). Keep in mind Canadians are quite free to invest in foreign ETFs trading on American and other stock exchanges. 

Jonathan Chevreau is founder of the Financial Independence Hub, author of Findependence Day and co-author of Victory Lap Retirement. He can be reached at jonathan@findependencehub.com.

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