By Christopher M. Wright

Broader Index Shares Do Not a REIT Allocation Make

Some investors believe that they have adequate exposure to REITs by virtue of holding index shares representing the S&P 500 or Russell 2000. Real Estate Portfolio sat down with Jordan Heller, CPA, CFA, CFP, managing director of financial and estate planning for the American Economic Planning Group (a comprehensive wealth management firm), who says, "that just isn't so." Heller has been in his current position for four years. He started his career as an accountant with Price Waterhouse in 1982. He spent 15 years on Wall Street, where he headed the real estate group in securities research at leading investment houses, including Merrill Lynch (10 years), Salomon Brothers (two years) and CIBC Oppenheimer (two years). He is also a current board member of Bed Bath & Beyond, Inc.

Portfolio: In the past, REITs were an often-misunderstood asset class and not included in most major indexes. Where do things stand today?
Heller: There are six REITs in the S&P 500, and they represent about half of 1 percent of the total equity capitalization of the index. There are 89 real estate companies in the Russell 2000, representing approximately 6 percent of its capitalization.

Portfolio: Is that enough exposure to real estate?
Heller: You don't have a lot of exposure to real estate if you are indexed to the S&P 500. Indexing to the Russell 2000 gives you somewhat greater exposure, but that may not be the level you want. Also, the REITs in these indexes may or may not be the ones you want. For example, one of the six real estate stocks in the S&P 500, Plum Creek Timber Company, Inc. (NYSE: PCL), is a timber company. This may or may not match what an investor might want in terms of real estate exposure.

Effective Allocations to REITs Through Investment in Major Equity Indexes REITs are included in many major equity market indexes, representing up to 8.65 percent of the Russell 2000 Value Index. However, as shown in the table, even large allocations to portfolios that track any of these indexes leave an investment portfolio with a less than optimum allocation to REITs.
REIT Constituents in Other Equity Indexes Data as of March 31, 2004		Number of REITs in Index	REIT Equity Market Capitalization (In thousands)	REIT Equity Market Weight¹ (In percent)
Standard & Poor's 500 Index		6	48,195,896	0.47
Wilshire Associates 4500 Index		175	2,993,273,678	7.45
Russell 2000 Index		89	70,467,376	5.84
Russell 2000 Value Index		85	67,948,763	8.64
	Effective Allocations to REITs (In percent)
Allocation to Other Equity Indexes (In percent)	S&P 500	Wilshire 4500	Russell 2000	Russell 2000 Value
5	0.02	0.37	0.29	0.43
10	0.05	0.75	0.58	0.86
15	0.07	1.12	0.88	1.30
20	0.09	1.49	1.17	1.73
25	0.12	1.86	1.46	2.16
30	0.14	2.24	1.75	2.59
35	0.16	2.61	2.04	3.02
40	0.19	2.98	2.34	3.46
45	0.21	3.35	2.63	3.89
50	0.23	3.73	2.92	4.32
Source: NAREIT ¹Market weightings determined by equity market capitalization.

Portfolio: How do the indexes stack up against the real estate allocations in your typical investment portfolios?
Heller: We run multi-asset portfolios with stocks, bonds, alternative investments, commodities and real estate. For our clients not in the real estate industry, we typically employ a separate real estate allocation, as we wouldn't get enough exposure if we limited ourselves to broad equity markets, such as these indexes. We like the risk-reward characteristics of real estate, so we supplement what's in the indexes with REIT funds, be it mutual funds or separate accounts directed by managers who know the business and can spot the opportunities.

Our clients are wealthy individuals. We typically allocate 5 percent to 8 percent of their portfolios to real estate. We also run 401(k), profit sharing and deferred compensation plans and offer a REIT investment option in all of these plans.

Portfolio: That's more than the indexes provide. What is it you like about real estate?
Heller: Real estate in general appeals to me. Stocks and bonds are leading indicators and get priced by looking ahead the next two years plus. Real estate, on the other hand, is a lagging industry in terms of the economic cycle. Generally speaking, real estate is slower to react to changes in the economy. So the real estate market behaves differently from stocks and bonds. That's good for diversification and makes it that much easier to spot the trends. When we combine real estate with stocks, bonds, hedge funds and commodities, we're finding the risk-reward characteristics of our portfolios to be very attractive.

Portfolio: What do you find most attractive regarding REIT investments?
Heller: It's the combination of yield, moderate growth, moderate risk, and low correlation to our other investments. These are attractive characteristics, and we like the fact that there are hard assets—real brick-and-mortar properties—backing up our investments. The fact that we know and like many of the managers of these real estate companies along with the fund managers themselves makes it even more appealing to our clients and us.

Portfolio: You mentioned diversification. Do you use REITs to diversify your portfolios?
Heller: Yes. The correlation between a broad-based REIT portfolio and the broader equity indexes is well below 0.5, supporting the diversification story that REITs have to tell.