As you all know from my previous articles, dividend investing is my favorite style of investing. Although along with that, I also like to make sure my portfolio has different type of assets. One way to do this is via real estate. However not all of us have the money to pay every month for mortgage. Here is where Real Estate investment Trusts (REIT) come in.
What are REIT’s?
A REIT is a company that owns, operates and manages real estate assets around the world and collects rent to make money. There can be publicly traded or privately held REIT’s. The good thing about public REIT’s is that they are required by law to pay out at least 90% of their taxable income in form of dividends. This makes them excellent alternative to just normal dividend stocks. Public REIT’s usually operate in a single industry. For e.g. Data Center, Telecom towers, industrial, storage, healthcare properties etc. This is not a hard and fast rule though. Some REIT’s do invest in all types of properties. There are also some REIT’s which invest in mortgages and make money using the interest payments on mortgage instead of collecting rents and managing properties. They are called mREIT’s but we will only be focusing on Publicly traded normal REIT in this article.
Advantages of REIT’s
Juicy Dividend Yields
Since REIT’s are legally mandated to pay at least 90% of their taxable income, they have high dividend yields. Most REIT’s can pay 4-5 or even 7% sustainable dividend yields. As compared to the average 2-3% dividend of rest of the S&P 500, REIT’s dividends are amazing! These yields are also usually very stable since most tenants are in long term leases which have increases priced every year as per inflation at least. However, check out various ways to ensure/safeguard you keep getting dividends at the bottom of the article.
Instant Diversification
Since we know its very important to diversify in various asset classes in your portfolio. REIT’s help in this regard. REIT’s indirectly make you owner of real estate. They usually have low correlation with stocks so, helps with reducing risk in your portfolio. Plus, best part is you get to be a real estate owner without doing the hard work in maintaining or collecting rents or paying any mortgage. Agreed they do trade like stocks, but REIT underlying asset that produces income is real estate.
Liquidity
Publicly traded REIT’s can be bought and sold just like stocks. So its easier to re balance your portfolio if needed. There are other private platforms like Fundrise and Real Estate Mogul that allow you to invest in REIT’s. But they are bound by extra rules on when you can sell and how much you need minimum to invest. So, publicly traded REIT’s are what I would suggest buying.
Proven long term performance
REIT’s over the last 25-30 years have returned over 11% annually reinvesting dividends. That is a great rate of return for any asset class given the fact we have had 2 recessions in that time. (courtesy NAREIT)
This kind of performance has been almost second to no other group of equities.
Risks/Disadvantages of investing in REIT’s
Sensitivity to Rising rates
In a rising rate environment like today’s, REIT’s compete with other asset classes. For e.g bonds and US treasury rates increase which are usually safer than REIT’s. So a 3% bond would be appealing to people as compared to a 4% REIT with amount of risk involved and REIT usually under-performs. However, having said that if you are a young investor with retirement after a decade or two or more. Then what is there to worry about! Just relax and reinvest the dividends and watch your income from REIT stocks keep growing. Over long term even rising rates usually benefit economy and help in raising rents across most properties and helping REIT’s.
Industry Risks
Most REIT’s operate in a specific industry and are susceptible to business risks weighing down respective industry. For e.g. recent fears over retail apocalypse over slowing sales in 2016-2017 lead to huge decreases in stock prices of most retail-oriented REIT’s. However, if you just focused on fundamentals and bought/invested then, most REIT’s are way more up since then this year.
Tax treatment for you
As we know publicly traded REIT’s are required to pay out at least 90% of their taxable income and they are exempt from paying any income taxes. But then for this reason, you get taxed at full income tax rate on unqualified dividends you receive from REIT. Instead of the favorable tax treatment at lower tax bracket for normal dividend stocks. So, its important to understand what type of investing account they should go in to minimize taxes/eliminate taxes. Yes! its possible to pay absolutely no taxes on REIT’s and get the high dividend yield they offer.
Different Type of REIT Sectors
As mentioned, REIT’s can operate in different industries and business. Type of industry has a lot of impact on REIT’s ability to earn rents. Here are some examples:
- Industrial: These invest in making warehouses, distribution centers, logistics center for housing any kind of equipment’s, process, materials required by customers. Some examples include Prologis Inc, Plymouth Industrial etc.
- Telecom: These invest in creating tower sites that which network operators use to provide cell services. Some examples include American Tower, Crown Castle Inc etc.
- Data Center: These invest in building huge infrastructure for data centers which big tech companies rent. They are usually fitted with features like extra cooling, 24*7 power supply and extremely secure environment. Some examples include Digital Realty, Cyrus One etc.
- Retail: These invest in single standing or mall like shopping centers. Some examples include Realty Income, Store Capital etc.
- Healthcare: Theses invest in creating hospitals, nursing homes, skilled nursing facilities etc. Some examples include Omega Healthcare Inc, Sabra Healthcare etc.
Other sectors include Office, Residential, Timber based REIT’s etc. You can find more about them here. Its important to know that at any given time, its easily possible that one sector of business is booming and REIT’s involved in that sector will also be booming.
In Conclusion
There are a lot of other factors like adjusted funds from operations AFFO, management etc to look at when choosing REIT’s. Factors to ensuring/safeguarding that dividend yield. Correct investment accounts to buy REIT’s in etc. To know more on how to go about choosing best REIT’s please consider subscribing below for free to help support the blog.
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Yoda
I am just a programmer in my day job and aspire to become a financially independent person. Learning and sharing knowledge is what I feel will help me the most on this FI journey and so I created this blog.
