Investing for Success: The Role of REITs and Commodities in Your Portfolio
REITs (real estate investment trusts) and commodities represent two distinct asset classes that can play important roles in well-diversified investment portfolios. This comprehensive guide provides an in-depth look at everything you need to know about these unique investment options.
Key Takeaways
- REITs provide access to income-generating real estate and offer benefits like stable dividends, portfolio diversification, and attractive total returns.
- Commodities like energy, metals, agriculture, and livestock serve as hard assets that can hedge against inflation and provide additional diversification.
- Both REITs and commodities have risks to consider, but also unique return potential and diversification abilities.
- Proper evaluation and allocation between REITs and commodities can provide balance to an investment portfolio.
Definition of REITs
A REIT (real estate investment trust) is a company that owns, operates, or finances income-generating real estate. Publicly traded REITs provide everyday investors with access to the benefits of commercial real estate assets.
Some key facts about REITs:
- Accessible to all investors via publicly traded markets
- Must derive at least 75% of revenue from real estate
- Required to distribute 90% of taxable income as dividends
- No corporate income tax levied at the REIT level
By pooling investor capital to purchase real estate, REITs allow individual investors to participate in sizable income-producing assets.
Definition of Commodities
Commodities represent physical raw materials and basic goods that are bought and sold globally on commodity exchanges. This includes:
- Energy: Crude oil, natural gas, gasoline, heating oil
- Metals: Gold, silver, platinum, copper
- Agriculture: Corn, soybeans, wheat, coffee
- Livestock: Live cattle, lean hogs, pork bellies
Traded via futures contracts, commodities serve key roles in the global economy and as investable assets.
Unique characteristics of both REITs and Commodities as investment options
REITs provide liquid real estate exposure and consistent dividend income based on ongoing rental activities.
Commodities serve as hard assets and an inflation hedge that operates independently of equities/fixed income.
Both offer strong portfolio diversification options.
Importance of understanding REITs and Commodities in diversified investment portfolios
Adding exposure to REITs and commodities can enhance overall portfolio risk-adjusted returns:
- Manage risk through asset class diversification
- Balance equities, fixed income, cash, and alternative assets
- Take advantage of unique inflation sensitivity
- Tap into global economic growth dynamics
Exposure allows tailoring to precise investment goals and risk tolerance levels.
Understanding REITs and Commodities
Definition and Purpose of REITs
REITs allow everyday investors to participate in sizable income-producing real estate holdings.
What are REITs?
- Public companies that own, operate, or finance real estate
- Trade on major stock exchanges like ordinary stocks
- Required to pay 90% of taxable income as dividends
REITs provide clear advantages:
Liquidity – Buy/sell shares easily in public markets
Diversification – Add real estate to traditional portfolios
Dividend Income – Consistent payouts from rental/mortgage activities
By issuing shares and using IPO capital to purchase property assets, REITs allow investors indirect exposure.
Definition and Characteristics of Commodities
What are Commodities Investments?
Commodities represent physical raw materials central to global economic activity:
Categories
- Energy: Crude oil, natural gas
- Metals: Gold, silver, copper
- Agriculture: Corn, wheat, coffee
- Livestock: Live cattle, lean hogs
Common Attributes
- Basic goods with intrinsic value
- Fungible and interchangeable
- Produced, stored, transported, and actively traded all over the world
Pricing
- Traded on exchanges via futures contracts
- Daily price fluctuations based on supply/demand
- Macroeconomic factors impact value
Why Commodities Matter
Every business relies in some way on raw materials making commodities essential to global economic growth.
1. Basic definition of commodities
Commodities Defined
Commodities are interchangeable basic goods used in commerce that are extracted, grown, produced, and actively traded across global markets.
2. Key characteristics
Key Attributes
- Basic Goods: Raw materials, crops, livestock
- Fungible: Largely interchangeable
- Physical Substances: As opposed to intangible assets
- Globally Traded: Buyers/sellers active worldwide
Pricing
- Traded on exchanges via futures contracts
- Prices fluctuate daily based on supply/demand
3. Types of commodities
Major commodity sectors:
- Energy – Crude oil, natural gas, coal
- Metals – Gold, silver, copper, platinum
- Agriculture – Corn, coffee, cocoa, sugar, soybeans
- Livestock – Cattle, hogs, pork bellies
From electricity to livestock feed, these raw materials support global economic growth.
Overview of the Role of REITs and Commodities in the Stock Market
REITs offer liquid real estate exposure and dividend income for stock investors.
Commodities provide inflation-resistant hard assets and an independent performance stream.
Adding both REITs and commodities provides further portfolio diversification.
How REITs Work and Make Money
Income-Generating Real Estate
REITs generate most profits from rents on owned real estate properties:
Property Types
- Apartments
- Offices
- Warehouses
- Hotels
- Retail Centers
Charging rent on holdings creates steady income streams. Gains also occur when strategically selling assets.
Capital Pooling and Individual Investor Dividends
Public REITs pool money from individual investors to assemble real estate portfolios:
Investor Funds → REITs → Income-Producing Real Estate
Ongoing rental activities provide cash for distribution to shareholders.
Benefits to Investors
- Liquidity of public markets
- Diversification beyond stocks/bonds
- Quarterly REIT dividend payouts
- Primarily from rental income
- Avoid double taxation
Liquidity and Public Trading
Investor capital is raised via an initial public offering (IPO). Shares then trade openly on stock exchanges.
IPO Launch → Public Listing → Exchange Trading
This makes holdings fairly liquid compared to owning physical real estate outright.
Daily buy/sell activity allows entering/exiting positions by trading shares through:
- Online brokerages
- Retirement accounts like IRAs
- Robo-advisors
- Financial advisors
How Commodities Are Traded
Commodities largely trade via futures contracts on exchanges worldwide.
1. Tradition of futures trading
Purpose of Futures
An agreement to buy or sell a commodity at a predetermined future date for an agreed price. This helps commodity producers hedge risk.
Contract Elements
- Buyer commits to purchasing a set quantity
- The seller agrees to provide that amount
- Trade price locked regardless of market price on delivery date
Main Goals
- Guarantee access at an agreed rate
- Manage pricing risks
2. Contracts to buy/sell at set prices
Futures contracts allow buyers and sellers to establish prices ahead of delivery.
Benefits:
Buyers
- Secures needed quantities at fixed rates
- Avoid pricing risks
Sellers
- Locks in revenue despite market drops
- Mitigates sharp pullbacks
This price certainty helps smooth market volatility.
3. Role of exchanges like COMEX, NYMEX
Exchanges like COMEX and NYMEX match buyers/sellers in centralized marketplaces. This allows for price discovery and smooth commodities trading.
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4. Spot vs futures markets
Spot Market – For immediate delivery priced at current rates
Futures Market – Locks predefined prices for delivery later
Both facilitate transactions but the futures market reduces pricing risks.
5. Factors that impact contract prices
Influences on Pricing
- Current supply/demand
- Production costs
- Storage/transport expenses
- Seasonal impacts
- Global weather/events
- Macro dynamics like inflation
Myriad shifting factors keep commodities volatile.
Types of REITs and Types of Commodities
types of REITs Table
| REIT Type | Description | Revenue Source |
|---|---|---|
| Equity | Owns/operates properties like offices and malls | Rental income |
| Mortgage | Finances real estate by originating or purchasing mortgages | Interest payments |
| Hybrid | The mix of equity and mortgage models | Rent and interest |
A. Types of REITs: Equity, Mortgage, Hybrid
Equity REITs
- Owns and operates income properties
- Revenue from rents
Mortgage REITs
- Originates or acquires real estate loans and mortgages
- Revenue from mortgage interest
Hybrid REITs
- Combination of equity and mortgage models
- Diversified real estate asset classes
This variety caters to precise risk tolerances and income requirements.
B. Examples of Major Commodity Sectors
Commodity Sector Details
| Sector | Major Commodities | Key Details |
|---|---|---|
| Energy | Oil, natural gas, gasoline | Powers global transportation and utilities |
| Metals | Gold, silver, copper | Used heavily in electronics and batteries |
| Agriculture | Corn, coffee, sugar | Provides food and biofuel feedstocks |
| Livestock | Cattle, hogs | Supplies global protein demand |
Four distinct commodity sectors exist:
- Energy
Types:
- Oil
- Natural gas
- Gasoline
- Heating oil
Uses:
Fuels global economic activity from transportation to utilities to manufacturing.
- Metals
Types:
- Gold
- Silver
- Platinum
- Copper
Uses:
Essential materials for electronics, vehicles, appliances, jewelry, and industrial applications.
III. Agriculture
Types:
- Corn
- Wheat
- Coffee
- Cocoa
- Sugar
- Soybeans
Uses:
Food production along with alternatives like biofuels.
- Livestock
Types:
- Cattle
- Hogs
- Pork bellies
Uses: Moved through the supply chain to support global protein consumption.
Output moves through the supply chain before landing on consumer plates.
1. Energy Commodities
Energy Types
- Crude oil
- Natural gas
- Gasoline
- Diesel fuel
- Jet fuel
- Coal
Vital to economic growth and functioning across transportation, utilities, manufacturing, and more.
2. Metal Commodities
Metals Classes
- Precious (Gold, silver)
- Industrial (Copper, aluminum)
- Rare Earth (Lithium, cobalt)
Applications span electronics, medicine, batteries, aerospace, jewelry, and machinery.
3. Agricultural Commodities
Major Agriculture Commodities
- Grains (Corn, wheat, rice)
- Oilseeds (Soybeans, palm, canola)
- Softs (Coffee, cocoa, sugar)
Providing sustenance remains the core purpose underpinning agricultural commodities.
4. Livestock Commodities
Key Livestock
- Cattle
- Hogs
- Chickens
Ranched and processed to satisfy massive global protein demand.
Output moves through supply chain before landing on consumer plates.
Investing in REITs and Commodities
REIT Investment Options
| Vehicle | Description | Considerations |
|---|---|---|
| Stocks | Buy shares of public REITs | Easy, liquid |
| ETFs | Basket of REITs in a single fund | Cost-effective diversification |
| Mutual Funds | Actively managed grouping of REITs | Higher costs, potential outperformance |
| Crowdfunding | Pool money with others in REITs | Higher risk, private offerings |
A. Publicly Traded REITs and SEC Regulation
Public REITs trade on stock exchanges making them highly liquid. Strict SEC oversight protects investors.
B. Public Non-Traded REITs and SEC Registration
Public non-traded REITs registered with the SEC but don’t trade on exchanges. Exit options are provided through repurchase plans.
C. Private REITs and Limited Access
Unregistered with the SEC having higher investment minimums. Typically accessible only to accredited and institutional investors.
D. How to Invest in REITs: Stocks, Mutual Funds, ETFs, Crowdfunding
Individual Stocks – Buy shares of public REITs on exchanges
Mutual Funds – Professionally managed baskets of REITs
ETFs – Index-based REITs exchange-traded funds
Crowdfunding – Pool money with others to invest
This democratization of access attracts both novice and professional investors.
E. Why Invest in Commodities?
- Diversification
Commodities behave distinctly from equity/bond markets helping diminish portfolio volatility.
- Inflation Hedge
Hard asset values historically keep better pace with rising prices.
III. Global Economic Exposure
Commodity demand is intimately tied to worldwide growth patterns.
- Growth Potential
While volatile, prolonged upcycles across decades occur as in China’s recent growth.
Why Invest in REITs and Commodities?
- Historical REIT vs. S&P 500 Returns
| Year | REIT Returns | S&P 500 Returns |
|---|---|---|
| 2020 | -8.0% | 16.3% |
| 2019 | 29.0% | 31.5% |
| 2018 | -4.0% | -6.2% |
| 2017 | 8.7% | 19.4% |
A. Three Key Benefits of REITs: Stable Dividends, Diversification, Attractive Returns
- Reliable Dividend Income
Quarterly shareholder payouts primarily derived from rents offer consistent cash flows.
- Portfolio Risk Management
Real estate demonstrates low correlations to equities/bonds helping smooth volatility.
III. Total Returns
Combination of stock price gains in growth periods and ongoing dividends.
B. Three Key Benefits of Commodities: Inflation Protection, Diversification, Return Potential
- Inflation Hedge
Rising commodity values shield against inflation erosion better than other securities.
- Reduced Portfolio Volatility
Commodities provide differentiation from equity/bond risk exposures.
III. Asymmetric Return Potential
While volatile, prolonged upcycles across decades occur as in China’s recent growth.
C. Real Assets vs. Financial Assets in REITs and Commodities
Real Assets – Physical property like real estate and raw materials that hold intrinsic value, like gold or oil, are independent of financial markets.
Financial Assets – Securities like stocks and bonds that essentially represent claims valued relative to risk/reward calculations by market participants. Their worth depends on the smooth functioning of financial markets.
REITs and commodities qualify as real assets – a distinction that can make them strategic portfolio additions.
Risks Associated with REITs and Commodities
A. Risks in REIT Investing
Key Risk Factors
- Vulnerability to stock market volatility
- Limited upside compared to growth stocks
- Unfavorable tax treatment of dividends
Payoff between return potential and risks requires evaluation.
B. Risks in Commodity Investing
Commodities carry significant risk factors including:
- Price Volatility
Shifts in fundamental supply/demand dynamics may trigger violent price swings.
- Complex Supply/Demand Analysis
Modeling the myriad macroeconomic variables accurately proves difficult for forecasting prices.
III. Geopolitical Issues
Political instability in key producing regions can suddenly restrict commodity flows.
Ongoing active risk management is critical when holding commodities.
1. Prone to price volatility
Sudden supply or demand shocks can drive dramatic price spikes and declines.
Examples
- War closing major oil supply channel
- Drought decimating crop harvests
- Rapid emerging market development ramping materials demand
This volatility requires disciplined risk management.
2. Complex to analyze supply/demand
Numerous intricate variables make reliable forecasting challenging:
Examples
- Global production capacities
- Inventory stockpiles
- Weather impacts
- Delivery logistics
- Currency impacts on global flows
Even seasoned experts struggle to consistently predict prices accurately.
3. Storage costs can impact prices
Holding commodities inventory until needed or while awaiting favorable prices carries expenses for facilities, insurance, and management. These carrying costs get baked into market pricing.
4. Geopolitics can disrupt markets
Commodity supplies may be relying on stability in a few key international regions. Issues can dramatically impact pricing:
Potential Disruptions
- War closing a strategic global shipping passage
- Embargoes or economic sanctions on major commodity producers or exporters
- Civil unrest interrupting extraction or harvesting
Geo-economic linkages create systemic risks to monitor.
How to Evaluate REITs and Commodities as Investments
A. Key Ratios for REITs: FFO, Dividend Yield, Debt Ratios
FFO – Funds From Operations indicates core earnings power
Dividend Yield % – Key income metric based on annual payout
Debt Ratios – Evaluate capacity to service obligations
These help assess financial health and cash flow generation.
B. Portfolio Diversification for REITs and Commodities
Adding REITs/commodities to a stock/bond portfolio enhances risk-adjusted returns:
Benefits
- Manage volatility
- Improve Sharpe Ratio optimized returns
- Take advantage of non-correlated performance
Diversification allows accessing upside potential while controlling drawdowns.
C. Management Team and Occupancy Rates for REITs, Hedging for Commodities
REITs
- Strong leadership navigates market shifts
- High occupancy translates to greater rental income
Commodities
- Hedging via futures contracts manages pricing risks
- Keeping low inventory levels contained losses
Ongoing active oversight by knowledgeable veterans helps steer through inevitable volatility – a key for maximizing returns from both asset classes over long-term holding periods aligned with financial objectives.
How to Get Started with Commodity Trading
For newcomers, the basics of commodity trading involve:
A. Open a brokerage account
Choose an online broker that provides access to commodity markets and futures trading.
B. Research commodities and futures
Gain knowledge about production, supply/demand, seasonal impacts, and macroeconomic factors that influence pricing.
C. Start small to get experience
Limit initial positions to get exposure before expanding to larger holdings over time.
D. Use stop-losses to limit downside
Set automatic selling triggers to prevent excessive losses if prices decline sharply.
Key Takeaways and Summary
- REITs provide liquid real estate exposure and dividends by pooling investor money into income properties.
- Commodities offer inflation protection and portfolio diversification as hard assets with intrinsic value.
- Evaluate REITs using metrics like FFO and dividend yields along with debt ratios and management quality.
- Research commodity fundamentals carefully as complex supply/demand dynamics impact prices.
- Adding some REITs and commodities to a stock/bond portfolio can reduce overall risk exposure.
Frequently Asked Questions
A. FAQs about REITs
What are the tax advantages of REITs?
REITs avoid corporate income taxes if they distribute 90% of taxable income as shareholder dividends. This avoids double taxation.
What is the best way to invest in REITs?
The simplest method is buying shares of publicly traded REITs on major stock exchanges via an online brokerage account.
How are REIT dividends taxed?
REIT dividends are taxed as ordinary income, but may qualify for a 20% deduction on qualified dividends. Always consult a tax professional.
B. FAQs about Commodities
What factors impact commodities prices?
Prices fluctuate based on global supply/demand shocks, production/storage costs, inflation/interest rates, and geopolitics.
How can commodities be incorporated into an investment portfolio?
Commodities can be added to portfolios via futures contracts or commodity ETFs and mutual funds that provide exposure to physical materials.
What are the best commodities to invest in?
The optimal mix of commodities depends on risk tolerance, time horizon, and investment goals. Work with a financial advisor to determine allocation.
Related Insights
A. Additional Perspectives on REITs
REITs represent a unique way for everyday investors to access the benefits of income-producing real estate. While promising as portfolio additions, further perspectives should be explored to determine if suitable for your individual financial situation and goals.
As discussed throughout this guide, key advantages of REIT investing include:
- Dividend Income – Quarterly payouts primarily derived from rental activities
- Diversification – Real estate historically demonstrates a low correlation to equities/bonds
- Profession Management – Public REITs overseen by experienced leadership teams with real estate expertise
- Liquidity – Ability to buy/sell exchange-traded REIT shares quickly for cash needs
However, REITs also carry risks to weigh like susceptibility to broader stock market volatility, taxation considerations, and limitations around returns relative to growth equities over longer-term periods.
Evaluating your risk tolerance, time horizon, income needs, and position relative to retirement remains paramount when assessing any allocation to REITs. Those nearer to retirement may opt for more fixed income over equities given the sequencing of returns risk. Still, holding some REIT exposure for ongoing dividends can prove prudent as part of an income sustainability strategy.
Be sure to continue further research and have thoughtful discussions with financial advisors to determine what portion of a portfolio, if any, should contain publicly traded REITs. While attractive for certain investors, they aren’t necessarily appropriate in all circumstances given individual situations. Achieving clarity around your investment objectives and risk appetite is key prior to committing significant capital.
B. Expert Viewpoints on Commodities and Current Market Trends
Commodity markets remain complex and often mysterious for casual observers. Gaining valuable perspectives from experts closely monitoring fundamental supply and demand dynamics across critical raw materials represents a wise move for those evaluating exposure.
In a recent interview, veteran commodities portfolio manager Frank Holland shared current insights about markets he follows closely:
On Energy Complex
While fossil fuels face mounting environmental pressures longer-term, demand still far outpaces supplies keeping near-term pricing buoyant. Holland sees oil testing $100/barrel in 2023 absent recession.
On Agriculture Markets
Grain prices are elevated on weather impacts reducing yields and inflation allowing producers to raise prices. But supply/demand coming back into balance on recession concerns.
On Livestock Futures
Lean hogs and live cattle contracts are volatile but Holland expects consolidation around current levels amid stable demand and consumer preference shifts.
On Metals and Mining
Precious metals firming due to inflation/geopolitics. Base metals holding up on chronic underinvestment in new production. Both are solid longer-term bets.
In summary, Holland’s perspectives highlight how the shifting economic landscape continues impacting commodities. Careful active monitoring of markets is essential to navigate complexities and volatility.
Where REITs and Commodities Are Traded
Global Commodity Exchanges
| Region | Major Exchanges |
|---|---|
| North America | CME Group, ICE |
| Europe | European Energy Exchange, London Metal Exchange |
| Asia | Shanghai Futures Exchange, Tokyo Commodity Exchange |
A. Major U.S. REIT Exchanges
New York Stock Exchange (NYSE), Nasdaq Stock Exchange, London Stock Exchange (LSE)
B. Major U.S. Commodity Exchanges
Chicago Mercantile Exchange (CME), Intercontinental Exchange (ICE), Chicago Board of Trade (CBOT)
C. Global Presence of Major REIT and Commodities Exchanges
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Conclusion
A. Recap of Key Points for REITs and Commodities
REITs and commodities offer unique portfolio diversification benefits alongside risks to weigh as part of overall portfolio allocation considerations between stocks, bonds, and alternative assets.
B. Encouragement for Further Research and Consultation with Financial Professionals
With the right education and perspective, adding some exposure to REITs and commodities can potentiate investment portfolio returns. This article aims to spur thinking, but further research is recommended alongside discussions with trusted financial professionals to determine suitability and asset allocation based on individual risk factors and goals.
