REITs or direct property funds? Navigating real estate in multi-asset portfolios

Property can play an important role in diversified portfolios, offering the potential for income, inflation sensitivity and diversification away from traditional equities and bonds. For advisers building or selecting multi asset solutions, property exposure is typically accessed in two distinct ways: listed Real Estate Investment Trusts (REITs) and direct property funds.

While both aim to provide exposure to real estate, understanding their differences is essential when assessing suitability, managing risk and setting client expectations.

REITs are listed companies that own, operate or finance income-producing property such as industrial, offices, retail parks, logistics warehouses, residential housing and specialist assets including healthcare facilities or data centres. Investor capital is pooled and professionally managed, with rental income typically distributed as dividends. Direct property funds invest directly in physical buildings – usually commercial scale properties. Returns are driven by rental income and changes in property valuations, rather than equity market sentiment (as is the case for REITs).

Liquidity is a central consideration when comparing REITs and direct property funds for inclusion in a multi-asset portfolio. REITs, as listed entities, are traded on stock exchanges and offer daily liquidity, meaning investors can buy or sell units quickly and efficiently. This flexibility enables portfolio managers and advisers to make swift adjustments to exposures in response to changing market conditions or economic events. The ability to transact at prevailing market prices also supports transparency, as REIT valuations are continuously updated and visible to investors.

Direct property funds typically offer much less frequent dealing, often only monthly or quarterly (or even less), as the underlying physical properties take time to buy, sell or value. During periods of elevated redemption demand – such as when market sentiment turns negative or investors seek to raise cash – direct property funds may impose restrictions, including gating, deferred withdrawals or reduced payout rates. This is designed to protect remaining investors and prevent forced sales of assets at unfavourable prices, but it can significantly limit access to capital for those wishing to exit.

For advisers and portfolio constructors, understanding these liquidity dynamics is crucial. While daily liquidity of REITs can be advantageous for tactical asset allocation and risk management, the less liquid nature of direct property funds may be better suited to long-term allocations where frequent trading is not required and investors accept some liquidity risk in exchange for potentially different return characteristics.

The way property exposure is valued can materially affect how it behaves within a portfolio. REIT prices can be volatile in the short term, reflecting equity market sentiment, interest rate expectations and changes in investor risk appetite. Direct property fund valuations tend to move more gradually, reflecting infrequent property appraisals rather than daily market pricing. While smoother returns may appear attractive, advisers should be clear that this reflects valuation methodology rather than the absence of risk. Underlying property values can still change meaningfully over time.

For advisers and portfolio constructors, understanding the liquidity dynamics of REITs and direct property funds is crucial.

Both property investment structures are affected by interest rates, but in different ways. REITs often respond quickly to changes in rate expectations, as higher yields can make income producing assets less attractive relative to bonds or cash. Direct property funds may show a slower response, with rate impacts feeding through gradually via valuations and rental demand. This distinction is important when considering how property exposure may behave during different phases of the economic cycle.

Income is often a key reason for including property in portfolios. REITs are typically structured to distribute a high proportion of rental income, resulting in relatively regular dividend payments. Direct property funds may also generate income, but distributions can be less predictable due to asset level costs, capital expenditure and liquidity management.

In practice, neither approach is inherently “better” – they simply serve different purposes. For advisers, the key is aligning the chosen route with the portfolio’s objectives, risk controls and client expectations. REITs are often favoured within multi asset portfolios for tactical asset allocation where liquidity, transparency and active risk management are priorities. Their listed nature allows them to be sized appropriately and adjusted over time alongside other asset classes. Direct property funds may be used where a closer link to physical property is desired, and where liquidity constraints are acceptable within the broader portfolio structure. Due to this illiquidity, direct property funds may be more suitable for longer term strategic asset allocation positioning.

Used appropriately within a multi asset framework, property exposure can support diversification and income – provided advisers are clear about what clients are investing in, and how it may behave across market cycles.