The biggest opportunity the average investor misses is real estate. Historically, real estate is the second best performing broad asset class, second only to stocks. Yet the conversations in the informational media tend to focus on finding some sort of age-based balance between stocks and bonds. Ignoring the potential of real estate investment is not good for your portfolio.
Some people choose to look away from real estate investment because of misconceptions. They think they would have to own buildings and deal with difficult tenants. This is an option, but not necessarily the best one for most people.
Most stock owners don’t get there by starting their own company; you don’t have to do the whole thing with real estate either. Real estate investment trusts (REITs) are an attractive option to going it alone.
Why Real Estate Investment
Having an asset class that gives stocks a run for their money would be reason enough but it gets better. If you use an asset allocation strategy or other portfolio modeling that includes real estate, you will likely find real estate as a sizable recommendation.
Real estate tends to have a low correlation with other asset classes — it helps stabilize a portfolio while enhancing the portfolio’s overall returns.
In most cases, adding real estate to a portfolio without any can decrease the portfolio’s volatility while simultaneously improving its performance.
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Why REITs
REITs are a great way for investors to add real estate to their portfolio. Most of us don’t want to deal with unruly tenants or broken pipes at 3 am. Nor can most of us, on an individual basis, invest in large-scale real estate. We can’t individually provide the real estate that major corporations need. REITs can. And do.
REITs must invest at least 75 percent of their assets in real estate. They must pay out at least 90 percent of their taxable income to their shareholders as dividends.
They bring professional management and a scale of opportunity that an individual investor can’t duplicate.
Types of REITs
The majority of REITs invest directly in real estate. They often specialize in a specific type of real estate, such as warehouses or health-care properties. But they can be apartment buildings or corporate offices as well. A smaller number of REITs are mortgage REITs, investing in mortgages and making their income from the financing side of the business.
Different types of real estate face different risks, for occupancy and other factors, so you’ll want to understand exactly what any REIT you’re considering invests in.
REITs can also be classified by how they are traded. Many REITs are publicly traded and can be purchased on exchanges. You can also invest in mutual funds and ETFs that invest in REITs.
Not all REITs are publicly traded. Some REITs can only be purchased directly, typically through a broker. These REITs can be very attractive opportunities but lack the liquidity of exchange traded REITs.
Costs and Risks
Costs can potentially be high. There are lots of variations in cost structures and you will want to research your favorites in depth. But don’t let costs dissuade you. Not everything that comes at a low cost or free is the best option. In the end it is never what it costs you that makes the difference; it’s what you keep that makes the difference.
The REIT organizations have to find, structure, and buy the properties and make the investment available to the public. There’s a lot that goes into all that. But there’s also a lot of transparency; you can find out your costs and know what they are in advance.
Risks in real estate come in several forms. It’s a good idea to limit your search to companies that have done this before and have a track record.
There are different risks associated with different types of real estate and the tenants that inhabit the properties. Residential and multi-tenant real estate may have greater risks of low occupancy rates. Commercial properties can vary based on the creditworthiness of the tenants they work with.
On the plus side, many REITs have diverse portfolios of properties spread around the country to manage or minimize risk.
Some REITs raise all the capital needed to purchase the properties; others use leverage. Raising 100 percent of the capital and purchasing the properties without debt is more conservative and reduces risk. Using leverage is less conservative but increases your upside potential.
REITs as an Income Alternative
Many retirees look for income producing investments to provide for their ongoing needs. The focus tends to be on bonds, as they are mainstream investments everyone is familiar with.
REITs can be a very attractive alternative to bonds for investors needing income. Many REITs are reliable income producers, paying a level or increasing dividend year after year. Most REITs also have some upside potential.
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In the end, a bond will ultimately be worth its face value and not a penny more. Real estate, on the other hand, is an appreciating asset. REITs shouldn’t be viewed as simply an income producing asset, but rather as a total return asset. You should be looking for a REIT that can both produce current income in the form of a dividend and also have upside appreciation potential.
For investors who understand the risks and can accept the risks, REITs are an attractive alternative to bonds for income needs.
The Bottom Line
REITs have gained in popularity due to their increased availability on exchanges and through mutual funds and ETFs. Many retirement plans also offer some form of REIT investment.
REITs are complex investments, but not much more so than other growth investments.
Investing has risks; investors need to do their homework to ensure they understand how the investment works and why it makes sense for them.
When you look forward, it would be hard to imagine that we would need less real estate or that people won’t need places to live and businesses won’t need some sorts of facilities.
Real estate is here to stay. Real estate has the potential to improve an investment portfolio’s returns while also decreasing the portfolio level of volatility. REITs make real estate investing easy.
