My name is “Nixon” and I’m a money addict. From close to 7 figures invested in equities, to multiple 7 figures invested in all types of real estate, if it makes money you have my attention. However, these and other investments are currently side hobbies as my day job entails being one of the primary executives at a Real Estate Investment Trust (REIT).
I’ve worked at a few different REITs in my career and have probably done some type of business with the WSPs or their peers. I’ve probably even rubbed elbows with the WSPs in Midtown and didn’t even know it. Probably at a property that was owned by a REIT.
Do you want to invest in a Manhattan skyscraper or maybe even a hotel in Beverly Hills? REITs are your best bet. Let’s get started.
What is a REIT?
A REIT is a company that invests in real estate either through owning properties or through providing mortgages, while distributing at least 90% of their income to shareholders (You) in the form of dividends.
There are considered to be four main “food groups” in real estate investing and this is where most REITs invest: multifamily, office, retail, and industrial. Besides the four food groups, there are numerous other types of real estate that REITs invest in: storage units, hotels, single family houses, hospitals, golf courses, student housing, data centers, timber, etc. Most REITs like to specialize in a specific area of real estate, but some will invest in as many types as they can.
REITs are basically spread investors, investing at cap rates that are greater than their cost of capital. The lower their cost of capital, and the higher the *risk-adjusted* return, the more money they are going to make. Note that REIT earnings are referred to as “Funds from Operations” (FFO) and not “Earnings Per Share” (EPS). FFO adds back depreciation (massive non-cash expense for REITs) in order to get closer to a true cash flow metric.
Dividends are typically paid to shareholders (You) quarterly, although some, such as Realty Income (NYSE: O), pay dividends monthly. If you’re gearing up for financial independence (or generating passive income), this is a fantastic way to get part of your income. Also, REITs typically increase their dividend payouts every year, and some REITs increase their dividend payouts multiple times a year.
Why Invest in REITs?
1) Income/Total Return: My favorite feature of REITs are the juicy dividends. The average dividend yield for REITs is in the 4% range (some even pay in the double digits!) while the average dividend for the S&P 500 is in the 2% range. REIT total returns have also typically exceeded the broader stock market over the long term when looking over various 20 and 30 year periods.
2) Ease: If you’re still nervous about investing in real estate after reading OwnMyHood’s excellent post , there is no easier way to get started than buying shares of a REIT. No repair calls, no chasing tenants for rent, no signing on the dotted line for mortgages, etc.
3) Liquidity: Maybe you need to sell your real estate quickly in order to take advantage of another opportunity, or maybe you’re feeling bad about the real estate market and want to exit. You can sell REIT stocks in seconds with a couple clicks of a mouse and get your cash out quick and easy. If you’re investing in physical real estate, you’re probably talking a few weeks to a couple months (maybe more) to get liquid.
4) Diversification: REITs invest in hundreds or even thousands of different properties in various locations (including outside the U.S.), so if one of their properties goes bust, it’s only a minor blip on the radar. As mentioned above, some REITs also invest in multiple asset classes, so if one asset class is underperforming, another is likely outperforming. Also, REITs are a great way to get some personal investment portfolio diversification when added to your bonds and other equities. Lastly, you’ll get access to properties and areas you wouldn’t otherwise have access to on your own.
How do I invest in REITs?
There are publicly-traded REITs and private/non-traded REITs. This post is focused more on publicly-traded REITs, because if you have access to purchase shares in non-traded REITs then you are probably accredited, which means you shouldn’t be reading this post anyway (although I know for a fact there are *numerous* accredited investors that frequent this site!).
Nearly 200 REITs are listed on the NYSE and can be purchased through your brokerage just as you would any other stock. There are numerous resources out there to help you analyze a REIT, including if you want pinpoint a certain asset class. Google is your friend.
I personally invest in several individual REITs in which believe in the strategy and long term strength of their portfolio. No, I will not share which companies, as you’ve read numerous times already that you never give away all your money-making secrets.
However, for the average investor I’d just recommend DCA investing in the Vanguard REIT Index (NYSE: VNQ). I also invest here due to the diversification benefit of investing in over 100 REITs (in addition to the other diversification benefits listed above), along with the tremendously low expense ratio of 12 bps.
Note: potential inefficiency from inflows towards ETF/passive investing has been on my radar and has also been mentioned several times by WSPs. If you don’t understand that sentence, maybe WSPs will educate with a future post.
Taxes and Dividends for REITs
Because REITs distribute most of their profits through dividends, they are exempt from paying taxes to the IRS. Instead, the shareholders (You) pay taxes on that income through the dividends you receive from the REIT. These dividends are generally taxed at your ordinary income tax rate vs. the qualified dividend tax rate. This means the IRS takes a larger chunk in taxes of the dividends paid from REITs than dividends paid from other companies.
However, because REITs distribute most of their income, dividend yields are typically higher for REIT stocks, as are the net after-tax yields. For example, SPY (the S&P 500 index with mostly qualified dividends) currently has a yield around 1.9%, whereas VNQ currently has a yield around 4.4%. After tax yields for VNQ (depending on your tax rate) are roughly 3%, whereas SPY is closer to 1.5% even taking into consideration the lower qualified dividend tax rate.
Note that because of the higher tax rates on dividends, REITs may be an excellent option to invest in within a tax-advantaged account like an IRA or 401K.
REIT Investing vs. Do It Yourself Real Estate Investing?
The short answer is both, however DIY may not be an option depending on your situation. If you’re looking for easier, or more liquid/diversified, real estate investing then REITs are probably for you. But if you’re willing to work hard, you can *absolutely*build more long term wealth through DIY. If you’re not willing to work hard you’re probably a normal person (looking for a magic pill) that stumbled onto this site by accident and won’t last too long.
That’s the high-level overview of REITs according to Nixon. Thanks to the WSP for handing over the keys for another real estate post (terrible pun intended)!
As always, I’ve gotta run, the money’s calling!
(Full disclosure: long VNQ)
WSPs Note: Similar to the prior guest post from ownmyhood, after vetting their credentials we’re allowing Nixon, RE Guy and Ownmyhood to post on Real Estate if they feel like giving blogging a try here and there with their free time. We would love to highlight that Nixon sent us this article during the “Final Four” because as he’s mentioned in the past he cares more about making $$ than watching dudes run around with a basketball. Since there is a recommendation by Nixon in the post regarding VNQ we are providing an overview of VNQ below.
Vanguard REIT ETF (Ticker: VNQ): The Vanguard REIT ETF is set up to 1) track the performance of the MSCI US REIT Index (which covers about 2/3 of the US REIT market, 2) build positions in REITS with a minimum requirement of $100M in market cap and 3) own and manage properties in retail, office, residential apartments & industrial spaces. From a market sub-segment perspective as of this writing the mix of investments is as follows: (Retail REITs 21.6%; Specialized REITs 16.5%; Residential REITs 15.7%; Office REITs 13.9%; Health Care REITs 12.3%; Diversified REITs 7.8%; Hotel & Resort REITs 6.1%; Industrial REITs 6.1%)
From a ETf Overview Perspective: 1) Dividend Yield of 4.4% today, 2) 0.12% expense ratio, 3) ~$65B in net assets, 4) 158 holdings, 5) Turnover rate of 6.70%