Understanding REITs

5/6/2014 2:43:55 PM

Ahsan Raheem, CFA®
Investment Analyst

How do REITs work?

AR: Real Estate Investment Trusts, or REITs for short, are securities that sell like a stock on the major exchanges and invest in real estate directly, either through properties or mortgages. They have unique characteristics that may be attractive to both income and growth investors.

How do investors use them in their portfolios?

AR: REITs can help provide income in conservative portfolios or long-term growth in more aggressive portfolios. Investors often think of REITs as a capital appreciation investment or a tool for growing portfolio wealth. While generally considered more volatile than bonds, REITs may offer higher income potential compared with other fixed-income investments. The law requires REITs to pay out at least 90 percent of their taxable income as dividends to shareholders who in turn pay income taxes on those dividends at ordinary rates.  

How about performance?

AR: REITs are potentially an important asset class for investors with a longer-term horizon. Stocks, bonds, cash and REITs generally do not react identically to the economic cycles. Combining REITs as part of asset allocation program may produce more appealing risk-and-return trade-offs and create a more diversified portfolio for an investor.

Over long holding periods, REITs returns have tended to outpace the rate of inflation, helping investors hedge the purchasing power of their portfolios. The rents and profits generated by commercial properties generally increase as inflation increases and are passed to REITs’ investors.  While inflation hasn’t been at alarming levels recently, it does, however, erode savings over long time periods. Investors looking for ways to achieve real returns may wish to consider asset classes that have historically performed well in periods of accelerating inflation.

How do you select investments in the Azzad REIT portfolio?

AR: Based on our ethical screens, we focus on high-quality, low-leveraged equity REITs. The REIT industry, in general, pursues higher leverage to boost profits. We believe high leverage in REITs exposes shareholders to more earnings risk, potentially decreasing returns in the long run. Highly leveraged REITs are also subject to higher financing risk, especially in an economy where interest rates are expected to rise. As interest rates rise, the cost of capital of many debt-laden REIT investments can increase, which could result in lower profitability for shareholders. We believe that low levels of debt enable a REIT investment to withstand economic shocks and keep the company’s management focused on improving operational efficiency and execution.

Are REITs necessary for a good asset allocation?

AR: That depends. Generally, though, we clearly see unique benefits of REITs as a part of an asset allocation strategy for a broad range of investor types. We think our unique investment philosophy in REITs create value for our investors.

To learn more about REITs and the role they should play in your asset allocation strategy, contact an Azzad investment advisor at 888.86.AZZAD.

Opinions expressed are those of the author or fund manager, are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security and should not be considered investment advice.

Fund holdings and sector allocations are subject to change and are not a recommendation to buy or sell any security. Click here for Azzad Ethical Fund current top 10 holdings. Click here for the Azzad Wise Capital Fund current top 10 holdings.

Past performance does not guarantee future results.

The Azzad Ethical Fund is non-diversified and may invest a larger percentage of its assets in fewer companies exposing it to more volatility and/or market risk than diversified funds. The Fund may not achieve its objective and/or could lose money on your investment in the Fund. Stock markets and investments in individual stocks can decline significantly in response to issuer, market, economic, political, regulatory, geographical, and other conditions. Investments in mid-cap companies can be more volatile than investments in larger companies. Investments in growth companies can be more sensitive to the company’s earnings and more volatile than the stock market in general. Because the portfolio may invest substantial amount of its asset in issuers located in a single country or in a limited number of countries, it may be more volatile that a portfolio that is more geographically diversified. See the prospectus for more details about risks.

Investments in smaller and medium sized companies involve additional risks such as limited liquidity and greater volatility. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower rated and non-rated securities present a great risk of loss to principal and interest than higher rated securities.

The Azzad Wise Capital Fund is non-diversified with a high concentration of securities in the financial sector which can expose the Fund to more volatility and/or market risk than diversified funds. The Fund may not achieve its objective and/or could lose money on your investment in the Fund. The Fund mainly invests in securities issues by foreign entities which expose the Fund to country specific risks such as market, economic, political, regulatory, geographical, and other risks. The Fund intends to invest in certain instruments that may be illiquid. As a result, if the Fund receives large amount of redemptions, the Fund may be forced to sell such illiquid investments at a significant loss to be able to meet such redemption requests. See the prospectus for more details about risks.