Real estate investing has always been an interest of mine and I’ve read many books on the subject. If you do your homework and acquire the right rental properties, you can build yourself a portfolio of assets that will provide a steady stream of passive income. This is appealing to me as I ponder how to best replace the income in my working years when I retire someday. Despite all I have read about rental real estate investing and its advantages, I personally never pursued investing in rental properties and don’t have any plans to. It does have some disadvantages – any of which can make it a deal breaker for an individual investor. It can be a very time-consuming process to find a suitable property. Not all properties make good rental investments and you need to make sure it will provide you with an acceptable return on investment. Real property is also not a liquid asset so if you need emergency cash, you will need to make sure you have adequate other liquid investments. It also requires you to take on debt. And lastly it requires you to deal with tenants, property maintenance issues, and other headaches of being a landlord. It was this last disadvantage that was my ultimate deciding factor not to do it. But I am still invested in real estate. How did I do that without acquiring rental properties?
Many people don’t know that you can invest in real estate without having to go out and buy an actual property. You can accomplish this by investing in Real Estate Investment Trusts (REITs). A REIT is a type of company that owns or finances income-producing real estate investments. The US created REITs in the 1960s for the specific purpose of providing access to income-producing commercial real estate which had been out of reach for the average individual investor. REITs are typically classified as either equity or mortgage REITs. Most REITs operate as equity REITs and is generally what is being referred to when you hear about them in the investment news. Equity REITs usually specialize in a specific sector with the most common being office, industrial, retail, lodging, apartments, timberland, healthcare, self-storage, and infrastructure. In order to be classified as a REIT, the company must meet certain requirements stipulated by the IRS. One characteristic that distinguishes REITs from other real estate companies is that they must acquire and develop their investments with the purpose of operating them for the income as opposed to selling the assets. In addition, REITs must distribute 90% of their taxable income to their shareholders in the form of dividend payments.
So how do you invest in REITs?
REITs are either public companies listed on major stock exchanges, public companies not listed on the exchanges, or are privately held. Individual investors can invest in REITs in a variety of ways; however, the easiest and most efficient way is to add them to your investment portfolio through mutual or exchange-traded funds. Currently, the US leads the world with the largest number of listed REITs with approximately $1.7 trillion in gross asset value, but this is rapidly changing as more than 35 countries have also adopted the REIT type. For maximum diversification consider including both US and global REIT funds in your portfolio. There are hundreds of REIT funds available to invest in but a few of my favorite funds include:
• SRET – Global X Super Dividend REIT
• VNQ – Vanguard Real Estate
• USRT – iShares Core US REIT
• DRW – WisdomTree Global ex-US Real Estate (Global)
So now you know what REITs are and how to invest in them. But you may be wondering if they have the same advantages as investing in an actual property. There are many reasons why investing in REITs is a smart move for your portfolio.
Diversification – REITs have a very low correlation to other markets like stocks and bonds. This helps to stabilize a portfolio during times of market volatility, reducing overall portfolio risk and increasing returns.
Tax Efficient Dividends – Since REITs must distribute 90% of their taxable income, these companies provide substantial and stable dividend income. In addition, the passage of the Tax Cuts and Jobs Act, which was signed into law in 2017, provides tax relief for REIT investors by allowing them to deduct up to 20% of the ordinary portion of REIT dividends.
Performance – Long term returns of REITs have been comparable to value equity returns and superior to fixed income investments. Their profitability is largely due to the contractual lease payments received by the tenants of the properties they own. Their strong performance leads to stock price increases and moderate long-term capital appreciation.
Inflation Hedging – A concern for many investors is the impact inflation causes to purchasing power over time. Equity investments have typically been used to reduce the effects of inflation, however, as investors move closer to retirement equity positions are cut back and replaced with safer fixed income securities. As an alternative, REITs can also be used as a hedge against inflation due to the business they are in. Their rents and values have historically increased along with prices in the overall economy which in turn leads to the dividend growth and capital appreciation.
Liquidity – Since REITs are traded on the major stock exchanges, they are considered a liquid investment. This makes them an attractive alternative for an investor concerned about liquidity issues of investing in rental properties.
If you are like me and have considered taking the plunge into the rental real estate world but are not comfortable with some of the difficulties of doing so, you can still invest in real estate through your investment portfolio. Not only will you get the passive income you are looking for, but it is an excellent way to add diversification to your overall investment portfolio.
Deborah Hobart, CPA is a Financial Advisor at Blue Water Capital Management, LLC, a fee-only financial advisory firm in Apex, NC.
