Real estate is prized by investors and investment managers for its ability to create stable investment returns while offering inflation protection. One of the most common real estate investment vehicles in the United States is the REIT. Through this structure, millions of investors try to get exposure to real estate. Some REITs list their shares publicly which gives owners, especially retail investors, significant liquidity. REITs are also tax-advantaged in that earnings are not taxed at the corporate level. However, there are limitations to using REITs as a substitute for direct real estate investment.
REITs vs. Direct Real Estate Ownership
REITs are combined investments of real estate and rental businesses. This means the real estate exposure offered comes with risks not inherent in direct real estate ownership. The operating nature of REITs compromises the key attributes that make real estate an attractive investment — namely real estate’s stable returns, low volatility, and inflation resistance.
To illustrate, let’s examine the single-family home market, represented by single-family rental (SFR) REITs like Invitation Homes (INVH) and American Homes 4 Rent (AMH), and direct real estate ownership as measured by the S&P Case-Shiller National Home Price Index (NHPI).
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- Returns: The returns of SFR REITs and home prices often diverge. Over the past two years (Jan 2021 to Dec 2022), an investor in INVH or AMH would have seen a total return of 3%, while home prices surged by over 24% during the same period.
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- Stability: The stability of REIT share prices compared to home prices is weak. Comparing the Sharpe Ratios for direct RE investing with SFR REITs shows a significant gap: Over the past six years, NHPI boasts a better Sharpe Ratio of 1.32 compared to 1.04 for INVH and 0.70 for AMH.
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- Inflation Protection: REIT share prices are less correlated with inflation than real estate prices. Over the last six years, while real estate prices has a 98% correlation with inflation, INVH and AMH have correlations of only 83%.
Though REITs are commonly thought of as replacements for real estate investing, the reality is that they do not offer the same investment characteristics as direct real estate ownership in U.S. residential housing.
REITs and Web3: Are they a good structure for bringing real estate on-chain?
Bringing real estate to Web3 is one of the holy grails of the Real World Assets (RWA) movement in the blockchain community. They imagine a fantastical future in which residents collectively own the built environments of their communities. As Web3 searches for legal structures to deliver real estate ownership, REITs are a common idea. Why aren’t there a huge number of REITs in Web3 today?
While REITs enjoy tax advantages by avoiding corporate taxes, this benefit only applies when they can identify their owners and distribute at least 90% of earnings. REIT managers who turn to blockchain for securitization rely on highly restricted security tokens to track and control ownership. These tokens end up looking like glorified Web2 shares, locked in closed ecosystems and lacking liquidity. In other words, REITs securitized via security tokens fail to fully harness the potential of Web3. Even if there was a path to a permissionless REIT token, it still wouldn’t address the limits SFR REITs face providing exposure to U.S housing.
Villcaso: A Novel Approach to On-Chain Real Estate
Villcaso creates a new kind of real estate investment product that combines the liquidity of public REIT shares, the return profile of direct real estate investments, and the permissionless capabilities of Web3. For more information, reach out to [email protected].
THIS IS NOT AN OFFER TO SELL SECURITIES. Information contained in this post is not an offer to sell securities or the solicitation of an offer to buy securities, nor shall there be any sale of securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of such jurisdiction.
