REITs: The easiest way to diversify into real estate
REITs are popular among many dividend investors yet a type of investment that most people are completely unfamiliar with. I first heard about them when researching for my own long-term dividend investment strategy back in September of last year. Since then, I have learned so much and REITs have become a favorite of mine to invest my money. In this piece I will go in depth about exactly what they are and what they offer.
What is a REIT?
REIT stands for Real Estate Investment Trust and is a specialty company structure created by the US congress in 1960. It is a popular way to structure a real estate corporation as it allows for certain tax benefits. REITs are similar to stocks in many ways as they allow anyone to invest in and benefit from the growth of any publicly traded company of this type, though specifically focused on real estate and renting out properties. While privately held REITs do exist, the ones we will go over today are of course publicly traded. REITs are available on major stock exchanges like NYSE and Nasdaq and because of this, they are very easy to mistake for any regular stock, but also make them just as accessible. They trade under individual ticker symbols just like any other stock and are often analyzed in the same way, though P/E ratios and alike do not quite offer the same level of insight into a REIT as for a regular stock.
Source: Ally Bank.
What makes REITs attractive for investors however are mostly two reasons:
It is the easiest way to diversify your holdings into real estate at a much smaller scale than purchasing your own property. You could purchase your first REIT for a few dollars per share and be on your way.
The second reason is interesting for those of us looking for a source of passive income. REITs all pay dividends consisting of their rental income and capital gains. To qualify as securities, REITs must pay out at least 90% of their net earnings to shareholders as dividends. This ties into the tax treatment mentioned above as this allow REITs to pay zero corporate taxes on the earnings they pay out as dividends.
In addition to this, to qualify as a REIT a few rules exist that the company must adhere to as well:
At least 75% of income must be related to real estate.
At least 75% of the company's assets must be in real estate.
At least 95% of all income has to be passive.
Even more different types of REITs
The greatest thing about REITs in my opinion, however, is the great diversify they offer. We already mentioned the three different kinds of REITs, but yet another categorization of these can be made: Equity and Mortgage type REITs.
Equity REITs own a wide range of properties like apartments, office buildings, shopping centers, and more. They will derive most of their income from the rent of those properties.
Mortgage REITs as the name may suggest collects revenue from interest earned on mortgages as well as mortgage-based securities.
But what is even more interesting is that within these categories exist a plethora of different specialized REITs with their focus area or principal strategy. Here are a few examples I like:
Digital Realty (DLR)
DLR is a cool example of a specialized REIT. They almost exclusively own data centers, upwards of 300 worldwide. They operate these data centers and rent out the space to different enterprises - they offer anywhere from single cabinets for equipment to entire data center buildings for rent. They pay out a dividend of just above 3% and have enjoyed a steady increase in the share price over the last many years.
Realty Income Corporation (O)
Realty Income is one of the most reputable and discussed REITs I have come across. It is beloved by dividend investors and indeed it has a place in my portfolio too. They are not so much unique in the type of property that they own, which is largely within retail, but Realty Income has a striking slogan: 'The Monthly Dividend Company'. This is pretty unique and they might even have been the first to do it (although I am not sure). It means that as a shareholder of this company I receive a dividend every single month, much like a regular salary. Their dividend sits currently at 4.14% and has been increasing for 25 consecutive years qualifying this REIT as a Dividend Aristocrat. Interestingly they recently announced a merger with VEREIT (VER), another REIT in an all-stock transaction, and plan to spin off any office-related assets they now own into its own company following the closing of the deal. This means I will soon be owning another REIT simply for holding this one. I really love this company and hope to pick up some more shares this year.
Simon Property Group (SPG)
Simon Property is the second largest REIT in the US and owns over 100 different malls and also around a hundred other types of shopping center and outlet store properties. Like most REITs they had a pretty tough time in early 2020, but Simon has bounced back harder than most. In April 2020 the share price was less than half what it is now, just a little than a year later. And given that they pay out around 4.45% in dividends at their current evaluation, it has been one of the best recovery plays I know of.
The many benefits of REITs
Overall, REITs are by far the easiest and most convenient way of entering the real estate market. They are as easy to buy as stock in any other company and therefore the barrier of entry is extremely low, starting at just a few dollars (though to receive any significant kind of dividends, you will likely have to invest a little more). You avoid the time consuming aspect of managing your own property and tending to your tenants troubles and inquiries and should you ever want to get rid of it, it is super easy to sell. It should also be considered that it is a lot less risky to own a small share of hundreds or thousands of buildings, rather than the entirety of a single property in a single location.
Returns are extremely consistent in form of dividends, often quarterly or even sometimes monthly, though under normal circumstances you should not expect huge growth in the share price itself. I personally started my investment journey in REITs last year, so at least for my first purchase, Federal Realty Investment Trust (FRT) I have seen near 50% growth already, on top of a very healthy dividend payout. It is important to note and be wary of how REITs are taxed where you live, as they are not always taxed in the same way as stocks. You also cannot build equity in REITs, which is a major benefit of traditional real estate investing. Many great arguments can be made for why any investor looking for a source of passive income should take a closer look at REITs. And if you are anything like me, likely to not own actual real estate until I buy my first house or apartment, Real Estate Investment Trusts serve as a great way to diversify into the space before that becomes an option.
Alternatives to REITs do exist. In Denmark for example, a company called The Many (previously known as Brickshare) offer a similar concept on a smaller scale. It is a sort of crowdfunding of local physical real estate - Though from what I have gathered, they offer less attractive returns at seemingly higher risks.
Disclaimer: I am not a financial advisor, the opinions expressed in this article are entirely my own – always invest at your own risk.
