Real property ownership (land, buildings, immovable property), and the collection of rents for income is as old as time. Owning land and real estate has long been a staple of wealth generation, and a symbol of wealth that was reserved for Kings and other royalty.
Of course, it’s 2015 and real property ownership is no longer reserved for blue bloods, but it still remains a staple of wealth generation. A Bloomberg study found that most Americans, approximately 60 percent, have their net worth tied up in real estate – specifically their primary residence. According to the study, “Since 1983, for 60 percent of U.S. households, the principal residence as a share of net worth has risen from 62 percent to 67 percent of total wealth.”
Besides the risk of having most of your total wealth tied up in your personal home, your home doesn’t generate income and isn’t very liquid (easy to dispose).
Some Stats on Rental Property and Rental Income
According to the IRS, less than 13% of US households in 2013 owned rental property. You may be surprised to learn that most rental properties in the US are owned by Wall Street (hedge funds) and Corporations. In 2013, approximately 36% of US households were renters. The median monthly rent was $905, and rental income increased approximately 240% from 2007 to 2013.
Being a landlord can be lucrative, but it is not for the faint of heart! Many ‘mom and pop’ landlords don’t reap the benefits until they have held the property for many years. Enter REITs.
What is a REIT?
REIT stands for Real Estate Investment Trust. REITs are companies that own, manage, or invest in real estate property and mortgage-backed securities. Most REITs are traded on stock exchanges like stocks and ETFs.
Some highlights of REITs are:
They must have at least 75% of their total assets invested in real-estate
They must distribute at least 90% of their taxable income to shareholders annually, usually in the form of quarterly or monthly dividend payments. For this reason, REITs can be a good source of income in an investment portfolio.
Advantages of REITs
REIT shares can be easily bought and sold, unlike rental property, AND you don’t need a huge down payment to get started.
REITs provide a stable income stream to investors in the form of dividends. You won’t need to hound tenants for rent payment, or deal with broken pipes at 2 in the morning to earn the income!
REITs provide diversification from other stock market investments and other real-estate properties that you own. As an example, if you own residential rental properties, you can invest in a commercial property REIT to gain diversification.
In general, REIT returns outperformed the S&P 500, Dow and NASDAQ Composite over a long-term horizon.
Although you don’t own the real estate properties directly, you can monitor the management and operations of the properties via quarterly and annual reports, and shareholder meetings.
Disadvantages of REITs
REITs are sensitive to interest rate fluctuations.
REIT dividend payouts are taxed as ordinary income, not dividend income (currently taxed at 15%). A good strategy to counter this is to have REITs in tax deferred accounts until you are in a lower tax bracket.
Share prices can fall when property values fall, and can fluctuate with the stock market based on supply and demand of shares.
REITs are highly leveraged, meaning they have a high amount of debt. They use debt to buy more real estate.
REITs are at the mercy of property tax changes, which can reduce income to shareholders.
Examples of different types of REITs
PENNYMAC MORTGAGE INVESTMENT TRUST (PMT) is a REIT invested mainly in residential property. PMT has a dividend yield of 14.19% (if you invest $1000, you will receive $141.90 annually in total dividend payments).
CORPORATE OFFICE PROPERTIES TRUST (OFC) is a REIT engaged in leasing and managing office spaces. OFC has a dividend yield of 4.58% (if you invest $1000, you will receive $45.80 annually in total dividend payments).
CBL AND ASSOCIATES PROPERTIES INC (CBL) is a REIT invested mainly in enclosed malls and open shopping centers. CBL has a dividend yield of 6.36% (if you invest $1000, you will receive $63.60 annually in total dividend payments).
Conclusion
REITs are an alternative to direct ownership of rental property, and unlike owning a rental property, REITs require a smaller investment of cash and time to get started. As with any other equity, REIT share prices fluctuate and dividend payments are not guaranteed. Always do your research, or consult a Financial Advisor before investing.