REITs Are Quietly Beating Stocks This Year

Howard Marks has a way of making the obvious sound radical. "In order to outperform," he wrote, "you have to depart from the crowd." The crowd right now is fixated on AI. Tech companies are spending trillions on infrastructure. New models drop weekly. Analysts project the shape of an AI economy a decade out when they cannot predict next week. Every financial news outlet is covering it. The noise is deafening.

The crowd is also wrong about something else. Commercial real estate, the asset class everyone hated two years ago, is quietly outperforming.

REITs have returned over 58% since their October 2023 low, or 18% annualized. That trails the S&P 500's 25% since then. The gap has narrowed sharply. Over the last 12 months REIT returns are roughly even with the S&P. This year REITs are ahead: up 16% while the S&P is up 9% and the Nasdaq 100 is up 11.6%. The move has attracted some coverage. Nothing like the wall-to-wall AI commentary.

What is more striking is that REITs are rising even as interest rates climb. They bottomed in October 2023 when the 10-year Treasury hit almost 5%. Since then rates have stayed elevated. The 90-day T-bill and the 2-year note both yield more than the Fed funds rate, a condition that has preceded a rate hike about 80% of the time historically. If one hike comes, more tend to follow. The market expects rates to go higher. REITs are rising anyway.

This has happened before. During the 1970s REITs fell with stocks in the 1973-74 bear market, largely on recession fears. After the recession ended rates kept rising. REITs did too, averaging 26% a year through the rest of the decade. From 1975 to 1986 REITs posted 12 consecutive up years. Real estate is sheltered from inflation by rising rents. At some point rising rents matter more than rising rates.

The fundamentals support the case. New supply is constrained because higher interest rates make development financing expensive. Balance sheets are in good shape. The sector's leverage ratio is about 35%. Rents and funds from operations are rising, with FFO up 14.8% in 2025. Work-from-home is fading slowly but steadily. Dividend yields are about 3.7%, well above the S&P 500's yield. Dividends rose 6.36% last year. Occupancy rates sit at 93.2%, historically strong. Many REITs trade below net asset value.

REITs are part of the strategic allocation in our client portfolios. The NAREIT All Equity REIT index dates to 1972. Since then its compound annual return is 10.8%, versus 11.2% for the S&P 500. The correlation between the two is about 0.5, meaning they move together roughly half the time. In the two extended periods when stocks performed poorly, REITs outperformed by wide margins. From 1972 through the end of that decade REITs returned 11.1% a year while the S&P returned 5.03%. For the decade starting in 2000 REITs returned 10.63% a year while the S&P returned negative 1%. REITs have delivered double-digit returns in every decade since inception except the 1990s, when they managed 9.14% a year.

They are not a perfect hedge. REITs fell more than stocks in 1973-74 and in 2007-08. Over long stretches when stocks struggle, they tend to hold up better.

This decade REITs have returned 5.1% annualized, well below their 10.8% long-term average. Stocks have run well above average at 15.2%. The crowd is chasing what has worked recently. The crowd is also wrong about commercial real estate, just as it was two years ago when the narrative was uniformly negative. After Silicon Valley Bank failed in spring 2023, no one wanted to touch the sector. Office vacancy fears, rate hike pain, recession talk. That was the point of maximum pessimism. No one noticed.

Crowds are not always wise. Sometimes they are herds, everyone doing the same thing because everyone else is doing the same thing. It works in both directions, overly optimistic and overly pessimistic. Long-term investors can take advantage through rebalancing. When an asset in your strategic allocation produces above-average returns, your allocation rises above target. When another produces below-average returns, the allocation falls below. Rebalancing forces you to sell high and buy low.

The fundamentals are favorable. New supply is constrained. Balance sheets are clean. Rents and FFO are rising. Dividends are growing. Occupancy is strong. Many REITs trade below NAV. The crowd is not paying attention.

I have no idea whether AI will revolutionize the world or end up a giant waste of investment capital. No matter what happens with it, people will need apartments, shopping centers, office buildings, warehouses, and probably data centers. Selling some stocks to buy some REITs is just good portfolio management. It is different, the essential element for outperformance.