At some point in your investing journey, you will encounter someone at a dinner party who owns rental properties and won't stop talking about it. They'll explain the tax benefits, the passive income, the appreciation, the hedge against inflation, how their grandfather's farmland is worth a thousand times what he paid for it — and you'll start to wonder if you're missing out by owning index funds instead of physical real estate.
You're probably not missing out. But you might want to consider adding some real estate exposure to your portfolio — through Real Estate Investment Trusts, or REITs — for reasons that have nothing to do with being a landlord.
Let's walk through what REITs are, what the data says about them, and whether they belong in your portfolio.
What Is a REIT and Why Does It Exist?
Congress created Real Estate Investment Trusts in 1960 to give ordinary investors access to income-generating real estate without having to buy and manage properties themselves. The structure is simple: a REIT is a company that owns, operates, or finances real estate assets — apartment buildings, shopping centers, hospitals, data centers, cell towers, warehouses — and is required by law to distribute at least 90% of its taxable income as dividends to shareholders.
That dividend requirement is why REITs carry higher yields than most stock funds. It's also why they're particularly sensitive to interest rates: when rates rise, REITs become less attractive relative to bonds, and their prices tend to fall. When rates fall, the yield advantage of REITs becomes more attractive, and prices rise.
The easiest way to invest in REITs is through VNQ (Vanguard Real Estate ETF), which holds about 150+ REITs across virtually every real estate sector at a 0.13% expense ratio — still cheap by any measure, though more than VTI's 0.03%.
The Historical Return Case for REITs
The performance data for REITs, while lumpy and period-dependent, makes a compelling long-term case.
From 1972 to 2023, the FTSE NAREIT All Equity REITs Index delivered a 12.7% total annual return versus 10.2% for the S&P 500. Over the past 25 years, REITs returned 11.4% annually versus 7.6% for the S&P 500. That's meaningful outperformance over very long periods.
The recent picture is different. Over the past 10 years, the S&P 500 has outperformed REITs significantly as technology mega-caps drove equity returns and rising interest rates hurt real estate valuations. From 2013-2023, the S&P 500 returned about 12.0% annually versus REITs at 9.5%. This is the same pattern we see with small cap value and international stocks — recent underperformance following a long period of outperformance.
The key statistical feature of REITs isn't just returns — it's the correlation with stocks and bonds. Research shows that global REITs have historically had lower correlation to both stocks and bonds than most asset classes, making them genuine diversifiers in a portfolio. Adding an asset that zigs when your other assets zag reduces overall portfolio volatility — even if that asset's standalone returns are similar to your existing holdings.
Wait — Don't I Already Own REITs Through VTI?
Yes, partially. VTI owns real estate sector stocks as part of its total market allocation. Real estate is typically about 3-4% of VTI's portfolio. So you're not completely without real estate exposure if you own VTI.
The question is whether that 3-4% allocation is enough to deliver the diversification benefit that REITs are capable of providing. Most research on REITs as a portfolio diversifier suggests you need at least 5-10% of your portfolio in REITs to meaningfully capture the diversification and income benefits. The 3-4% you get through VTI is better than nothing, but it's not a meaningful REIT tilt.
REITs belong in tax-advantaged accounts
REIT dividends are typically taxed as ordinary income rather than qualified dividends. This distinction matters a lot in a taxable account: qualified dividends are taxed at the lower long-term capital gains rate (0%, 15%, or 20%), while ordinary income is taxed at your marginal rate (up to 37%). If you hold VNQ in a taxable account, you'll owe income taxes on the substantial dividend yield every year. For this reason, REITs are significantly better held in tax-advantaged accounts (IRA, 401k) where dividends aren't immediately taxable. If you only have taxable accounts available, the tax drag on REIT dividends substantially reduces their attractiveness.
The Case Against Adding REITs
Before you go adding VNQ to every account you own, the counter-arguments deserve airtime.
Correlation increases in crises. REITs' low correlation to stocks is most pronounced during normal markets. During crises — 2008-2009, 2020 — REITs fell hard alongside everything else. When diversification matters most, it often works least. REITs dropped over 70% peak-to-trough in the 2008-2009 financial crisis.
Interest rate sensitivity. REITs hate rising rates. The 2022 rate hiking cycle crushed REIT valuations. If you're adding REITs, you're adding meaningful interest rate risk on top of your equity risk.
VTI already has some. If simplicity is your priority, the 3-4% real estate exposure in VTI might be sufficient. Adding a separate REIT allocation adds one more ticker to track and rebalance.
Should You Add REITs? The Verdict by Portfolio Tier
| Portfolio Tier | REIT Recommendation | Vehicle |
|---|---|---|
| Good (VTI only) | Skip VNQ — simplicity wins | VTI's 3-4% real estate is sufficient |
| Better | 5-10% in tax-advantaged account | VNQ (0.13%) |
| Best (Merriman-inspired) | 5-10% in tax-advantaged account | AVRE (0.17%) for factor consistency |
For the Best portfolio, Avantis offers AVRE (Avantis Real Estate ETF) at 0.17% expense ratio — a factor-tilted REIT option that applies the same profitability and value screens Avantis uses on equities. This fits coherently with the overall Avantis methodology if you're building a factor-aware portfolio.
The most honest REIT take
REITs are a legitimate diversifier with strong long-term data supporting their inclusion, but they're not essential. If you're already managing multiple Avantis factor ETFs and the idea of adding another moving part is mentally exhausting, don't. Your portfolio won't significantly suffer without a dedicated REIT allocation. The simplicity argument for skipping REITs is entirely defensible. If you do add them, keep it to a tax-advantaged account, keep the allocation to 5-10%, and hold through the inevitable periods when rising interest rates crush the sector.
The Bottom Line
REITs have historically delivered competitive long-term returns (12.7% annually from 1972-2023 for the NAREIT All Equity index), genuine diversification benefits versus stocks and bonds, and meaningful dividend income. VNQ is the simplest vehicle for this exposure at 0.13% expense ratio; AVRE is the factor-aware alternative at 0.17%.
The main limitations: recent underperformance, severe interest rate sensitivity, and tax inefficiency in taxable accounts. REITs work best in tax-advantaged accounts as a 5-10% allocation for investors who want real estate exposure without the landlord hassle.
If you're a Good portfolio investor — stay simple and skip the explicit REIT allocation. If you're building Better or Best and have an IRA or 401k with the fund option, VNQ or AVRE is a reasonable addition. Real estate has made a lot of people rich. You don't need to own a single property to benefit from that.
Disclaimer: VTI & Chill provides financial EDUCATION, not personalized financial ADVICE. We are not licensed financial advisors. All content is for informational and educational purposes only. Past performance does not guarantee future results. Always do your own research and consider consulting a qualified financial professional before making investment decisions. All investing involves risk, including the possible loss of principal.