Achieving Capital Preservation Through REIT Investing
~ Saturday, July 13, 2024 Blog Post ~
As years pass, I have transformed from being a conservative investor to a now relatively conservative investor. I am no longer fearful of letting go of my hard-earned investment money. Indeed, I have become more trusting in a slate of investment vehicles that I believe can deliver financial security for myself in the long run.
As a relatively conservative investor, my investment targets have been financial security, capital preservation, and maintaining my comfortable lifestyle in the long term. I have emphasized that I want to safeguard my savings and investments from inflation, which reduces the US dollar’s purchasing power and in which wage hikes are insufficient in offsetting.
Earning money for me is surely not only for my consumption. Through mastering the art of investing, I have become increasingly investment and financially savvy as I garnered and enriched myself with more insights regarding the investment vehicles capable of preserving my hard-earned money’s value. I have many investment options, such as government bonds with high yields that can already defeat inflation and aid in preserving my investment capital. There are also the high-risk equities and the generally illiquid real estate properties.
Last Wednesday, July 10, 2024, I spent an hour learning more about REIT investing, and I became more enlightened about this investment vehicle. Real estate investment trusts or REITs refer to companies that own, finance, or operate income-generating real estate properties. The latter comprise shopping centers, warehouses, apartment buildings, and offices. Besides retail centers, REIT companies invest in cell towers, medical facilities, data centers, residential condominiums, and hotels, among many others.
A REIT is modeled after mutual funds, which involve the pooling of capital investors. This investment vehicle has property and fund managers who ensure the companies’ proper management. Moreover, from the webinar, I learned that most REITs are publicly traded. They are dissimilar to real estate investments and more like highly liquid stocks.
The United States has a mature and developed REIT market. REITs are a part of the country’s stock market composite. Based on Dow Jones Market Data, several REITs, including office spaces and life sciences, notched their biggest one-day gains in November 2023. Among the well-known US REITs are Alexandria Real Estate Equities (Ticker: ARE), Vornado Realty Trust (VNO), and Boston Properties (BXP). BXP sold a 45-percent stake in two of its Boston life sciences properties worth US$1.66 billion to Norges Bank Investment Management. Broad fund Vanguard Real Estate exchange-traded fund (VNQ) has varied real estate-related holdings and REITs.
The REIT companies I invested in are large firms funding and managing new and high-growth real estate properties. These business establishments’ high-quality real estate property and asset investments consist of hotels, office buildings, and shopping malls situated in central business districts and other key growth areas.
As a REIT investor, I and many other owners or investors own a shopping mall that has a 90-percent occupancy rate. That particular REIT company pays 90 percent of its income to investors as dividends. The rent in the shopping mall reflects the price surges.
Additionally, I benefit from my REIT companies for investing in assets with a strong track record. These firms pay compelling dividend yields to investors who enjoy the perks of share price appreciation and above all, capital appreciation — my primary investing goal.
Indeed, being a REIT investor, I earn dividends from my firms’ real estate investments while not having to individually purchase, finance, or manage any real estate properties. I relish the steady income stream my investment generates. The REIT companies I invested in have a rosy outlook with strong foot traffic as they have the largest exposure to shopping centers.
As every investment generates returns, risks are also involved in REIT investing. I am well aware of the changing working and business environments with work-from-home arrangements and artificial intelligence or AI disruptions rising today. These transitions entail negative impacts on my REIT investments, specifically companies with the largest exposure to office buildings. Furthermore, I am at risk due to the REIT companies’ possible bankruptcy with startups entering their decline phase or the real estate properties involving buildings aging and becoming dilapidated due to wear and tear.
Investors generally anticipate falling refinancing difficulties and plummeting property values. Nonetheless, it is common for higher interest rates to drive down commercial real estate shares. Despite these negative investment realities, I still choose to become a REIT investor. I’m firmly convinced of this investment vehicle’s advantages to my investment portfolio, especially in challenging and uncertain market environments.
Moreover, I relish both dividends and capital appreciation with REITs which have more manageable risks compared to equities and real estate. Investors who are preferred share stock owners only rake in dividends and I am not after few or minimal financial benefits when it comes to my investments.
Even though the general REIT market today is adversely affected by high interest rates and inflation, which may result in a flattish or downward movement, I still can enjoy moderate returns and risks on my investments.
REIT investing also assists in my retirement fund, although the returns’ timing is uncertain. What is important for me is by having REITs in my investment portfolio, I get something out of my investment capital, thanks to the fixed dividend payments.
If I never opted to invest in REITs, I would have already been exposed to the hazard of the US dollar decreasing its value due to inflation. With equities investing, I can also be disadvantaged by selling at a loss. Therefore, I made the right decision with REIT investing since I get to benefit from rent income and substantial profits generated out of my investment. REITs can also be big winners in stock market rallies. Hence, this investment vehicle is not a bad idea at all.
REITs are a way to invest in real estate without buying real estate — here’s how they work and ways to invest [From Business Insider]
By Tara Mastroeni and Paul Kim, July 20, 2024
- Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-producing real estate ventures.
- Publicly traded REITs offer investors a liquid way to invest in real estate without having to buy or manage the property themselves.
- REITs provide a steady, high income stream and portfolio diversification, but they come with tax consequences and interest rate-related risks.
A real estate investment trust (REIT) allows people to invest in real estate without having to buy or manage any property themselves. Given that landlord duties go beyond the level of work most are interested in taking on, REITs are often the real estate investment of choice for individual investors. According to the National Association of Real Estate Investment Trusts (NAREIT), as of October 2020, an estimated 145 million Americans, or roughly 44% of US households, own REIT shares, most of which trade on major stock exchanges.
Many investors decide to add REITs to their portfolios because these products combine the ease and liquidity of investing in stocks with the opportunity to own, and profit from, real estate. Geared to generating income, REITs offer regular returns and outsized dividends.
What is a REIT?
REITs are companies that own, operate, or finance income-producing properties and real estate ventures. Like mutual funds or exchange-traded funds (ETFs), they own not just one, but a basket of assets. Investors purchase shares of a REIT and earn a proportionate share of the income produced by those assets.
REITs were created in 1960 when Congress established them as an amendment to the Cigar Excise Tax Extension, which allowed investors to buy shares in commercial real estate portfolios. Since then, REITs have grown to the point where, today, NAREIT estimates that REITs collectively own about $3.5 trillion in assets across the US.
REITs are appealing to investors who want to put money into the real estate market without having to own real estate. They’re also appealing because of the unique way that they are taxed. While most stock dividends are in effect taxed twice — first when the company pays its corporate taxes, then when the investor pays their income tax — REIT payouts are only taxed through investors. A REIT is structured as a pass-through entity, an entity that passes all of its income to investors or owners — which means, it doesn’t pay any corporate tax. This effectively means higher returns for its investors.
The rules of REITs
There are certain Internal Revenue Code (IRC) rules that a company must comply with in order to qualify as a REIT (and avoid those corporate taxes). They must be registered as corporations, and be managed by a board of trustees or directors.
A REIT must also:
- Distribute at least 90% of its annual taxable income in dividends
- Rent at least 90% of the property to people who are not subsidiaries of the REIT
- Derive at least 75% of its gross income from real estate
- Invest at least 75% of its total assets in real estate ventures, cash vehicles (bonds, etc.), or government securities
- Have at least 100 shareholders
- Have no more than 50% of its shares held by less than five individuals
Varieties of REITs
All REITs are oriented to producing income, but they do so in different ways. In total, there are three types.
Equity REITs
The vast majority of REITs fall into this category (and are what most people mean when they discuss REITs). This type actually owns and operates real estate properties. Its revenues come from rents, but it also offers the potential for capital appreciation from building sales.
Mortgage REITs
More of a strict income play, mortgage REITs, sometimes written as mREITs, don’t own property; rather, they offer or own mortgages on properties. Sometimes they hold actual mortgages, sometimes mortgage-backed securities. The revenues come from the mortgage payments, especially the interest on them. In general, mortgage REITs tend to be more leveraged than equity REITs, which makes them riskier.
Mortgage REITs profit by capturing the spread between their borrowing interest rate and the mortgage interest rates. If they’re borrowing money at a 1% interest rate to buy a mortgage with a 4% interest rate, they can pass that 3% spread onto their investors. This also means that mortgage REITs are particularly sensitive to interest rate changes. They lose value when interest rates drop.
Hybrid REITs
As the name suggests, hybrid REITs use a mix of investing strategies, owning both actual properties and mortgages. These are appealing to generalist investors who can’t decide one way or another between equity and mortgage REITs, though hybrid REITs tend to lean one way or another.
What do REITs invest in?
As long as a REIT complies with the IRC rules, it can invest in any sort of real estate property.
While REITs usually focus on one of these real estate sectors, some of them do hold multiple types of properties in their portfolios.
Are REITs right for you?
Before you can decide whether or not investing in REITs is right for you, it’s crucial to understand their advantages and disadvantages.
The advantages of investing in REITs
- High returns: Since REITs are required to pay 90% of their taxable income to shareholders, they tend to have higher-than-average dividend yields. In addition, they have the potential for capital appreciation as the value of their underlying assets grows over time.
- Portfolio diversification: Although REITs are technically stocks, they are considered a different asset class — part of the real estate sector, rather than general equities. So they provide a way to diversify your portfolio, always a good risk-offsetting strategy.
- Liquidity: Real estate is a notoriously illiquid investment: Buying and selling buildings takes a while. But if you need to unload a REIT, doing so is often as easy as clicking a button or calling your broker. And since they’re publicly traded, you can measure your investment’s worth daily.
The disadvantages of investing in REITs
- Higher taxes: The REIT itself gets a break on paying taxes. Unfortunately, the investor doesn’t. Since REIT payouts typically don’t meet the IRS definition for “qualified dividends,” your returns are taxed as ordinary income, which is a higher rate than other types of investments. Sales of your REIT stock are taxed like other stocks, as capital gains — but at the maximum capital gains rate of 20% (plus the 3.8% Medicare tax) on any profit.
- Interest rate sensitivity: REITs are generally very sensitive to interest rate fluctuations, especially those that invest in mortgages. In a rising interest rate environment, Treasury securities tend to become more attractive, which draws funds away from REITs and lowers their share prices.
- Sector risk: Although REITs are a great way to diversify your portfolio, they are rarely diversified within themselves. This means that if one type of commercial real estate is struggling, it can be bad for your REIT.
How to invest in REITs
There are several ways to invest in REITs.
Publicly traded REITs
These are the most common REITs, and the ones most individuals should consider. These REITs are regulated by the Securities Exchange Commission (SEC) and typically have a low minimum investment.
Public non-traded REITs
Also known as non-listed REITs, this type is still regulated by the SEC and subject to its reporting requirements, but the companies are not traded on a national stock exchange and are subject to certain investment limits. Inventors must purchase shares directly from the REIT or a third-party dealer.
Non-listed REITs are considerably more illiquid than public REITs, often with long time horizons. They can also come with high upfront transaction fees.
Private REITs
Private REITs are not required to register with the SEC. As such, they are designed for institutional or accredited investors and typically have a much higher minimum investment amount — often, in the five-figure range — and come with higher risk.
REIT funds
There’s an ETF or mutual fund for just about every asset, and REITs are no exception. Offered by investment companies like Vanguard or Fidelity, these vehicles are managed funds that invest the majority of their assets into REIT securities and related derivatives. If you want the maximum diversification, or just don’t want to research individual REITs, a REIT fund could be a good option.
The bottom line
REITs offer liquidity in real estate investing, something that seems contradictory. They can be a way to diversify your portfolio while gaining access to steady income and a little long-term capital appreciation.
However, while they eliminate many of the customary drawbacks of real estate, REITs also come with downsides. These include a higher tax rate and an inherent sensitivity to both interest-rate risk and market sector risk. Overall, though, they remain a relatively safe way for individual investors to make a property play.
References:
https://www.barrons.com/articles/reits-soar-higher-interest-rates-could-be-on-hold-4cc2df06
https://www.businessinsider.com/personal-finance/investing/what-is-a-reit
https://www.investopedia.com/terms/r/reit.asp
https://moneymorning.com/income-investing/reit/
https://www.wallstreetprep.com/knowledge/the-ultimate-guide-to-reits/
