Week 26 Day 3: SCHH: Real Estate Without the Tenants

REITs (Real Estate Investment Trusts) are companies that own income-producing real estate and are required to distribute 90% of their taxable income as dividends. SCHH holds 130+ REITs across all property types. You earn rental income (via dividends) plus property value appreciation. It is the easiest way to add real estate to your portfolio.

SCHH by the numbers: Expense ratio: 0.07%. Yield: approximately 3.0-4.0% (varies with interest rates). Holdings: approximately 130 U.S. REITs. 10-year annualized return: approximately 5-7% (REIT returns are cyclical). Top sectors: cell towers (American Tower, Crown Castle), data centers (Equinix, Digital Realty), industrial (Prologis), residential (AvalonBay, Equity Residential). Why include REITs? Diversification: real estate returns are not perfectly correlated with stock returns (correlation approximately 0.6-0.7 with VTI). When stocks fall because of high interest rates, REITs may also suffer -- but when stocks fall due to recession fears while rates are cut, REITs often benefit. Inflation hedge: rents tend to rise with inflation, providing a natural inflation hedge. Income: REIT dividends are higher than the broad market (3-4% vs 1.3% for VTI). The risk: REITs are sensitive to interest rates. When rates rise, REITs tend to underperform (as they did significantly in 2022-2023). A 5-10% allocation to SCHH in a diversified portfolio adds real estate exposure without the management burden of direct property ownership.

The academic case for REIT allocation rests on multiple factors: (1) partial completion of the 'market portfolio' -- publicly traded REITs represent approximately $1.4 trillion in market cap, a meaningful fraction of the investable U.S. real estate market. VTI includes REITs at market weight (approximately 3%), so SCHH represents an overweight to real estate. (2) The REIT factor premium: Anderson, Clayton, MacKinnon, and Sharma (2005) identified a REIT-specific risk factor that provides returns not fully explained by Fama-French factors, suggesting a unique risk premium for real estate. (3) Inflation sensitivity: Hoesli, Lizieri, and MacGregor (2008) found that REITs provide a partial inflation hedge over horizons of 5+ years, with rents adjusting to price levels over time. However, short-term REIT sensitivity to interest rates (duration of approximately 4-6 years for the REIT index) creates significant price volatility when monetary policy changes. Chaney and Hoesli (2010) estimated that a 100 basis point increase in the 10-year Treasury yield reduces REIT prices by approximately 8-12% in the short term. This is why REITs suffered in 2022 when the Fed raised rates by 500+ basis points. For long-term portfolio construction, an allocation of 5-15% to REITs (above the approximately 3% market weight in VTI) is supported by mean-variance optimization when using historical asset class returns and correlations, though the optimal allocation is sensitive to the estimation period chosen.