Are REITs a Good Investment?

Investors looking for ways to diversify their portfolio may find that REITs are recommended. This post will attempt to answer the following questions:

What Are REITs?
Are REITs a good investment?
What types of investors should consider REITs?
What are the risks of investing in REITs?
What REITs should I invest in?

 What Are REITs?

REIT is an acronym for Real Estate Investment Trust. A REIT is a shareholder-owned company that invests in and operates real estate or real-estate backed mortgages. It receives favorable tax treatment in that the REIT does not pay income taxes, but it is required to distribute 90% of its income to shareholders, who do pay taxes on the income.

Are REITs a Good Investment?

That’s like asking if stock is a good investment. It depends on the REIT and it depends on your goals.

Different REITs have different types of portfolios and different goals. As in any business, some are well-managed and others are not.

The first thing to remember about REITS is that they (hopefully) generate regular dividends, and those dividends are taxable income, unless the shares are inside an IRA. While some share appreciation is expected, on average, REIT shares appreciate less than shares in other businesses but pay higher dividends.

For example, VTI is a Vanguard index ETF that tries to match the return of the U.S. stock market, as a whole. VNQ is an ETF that invests in a large range of REITs. If you had invested $10,000 in each ten years ago, and reinvested all dividends, your returns would have tracked pretty closely most of the time, but since August, 2016, VTI has pulled ahead and now leads by about $4,000. However, percentage wise, VNQ’s dividends are about twice VTIs.

For investors looking for regular income, REITs can be a good investment.

What types of investors should consider REITs?

REITs serve two primary purposes in an investment portfolio: income and diversification. As noted earlier, REITs are required to pay 90% of their income to investors in dividends, which means that compare to many stocks, REITs pay high dividends. Some examples:

O: Realty Income Corp. invests in a diversified portfolio of real estate. Dividend Yield: 4.49%

OHI: Omega Healthcare Investors invests in leases and mortgages on healthcare facilities. Dividend Yield: 9.23%

GOV: Government Properties Income Trust owns and maintains properties leased to government entities. Yield: 9.277%

CBL: CBL & Associates Properties, Inc owns and operates retail properties. Dividend Yield: 17.58%

For investors who are looking for a quarterly, or in some cases monthly, REITs need to be seriously considered.

On the other hand, all investors need diversification in their portfolio, and real estate is a major investment class. Most people do not want the hassle of owning and operating rental property, be it residential, retail or commercial. Investing in REITs allows you to to own real estate and benefit from its gains (and suffer its losses) without the hassle of being a landlord.

What Are the Risks of Investing in REITs?

Like all investments, REITs carry risks. The two main risks of investing in REITs are market risk and company-specific risk. 

As all of us who own real estate know, the price of real estate does not predictably rise. Rents do not always keep pace with expenses. REITs have the same issues. If real estate prices are going through the roof, investors will pay more for REIT shares; if real estate prices are flat or decreasing, share prices will be flat or even decrease.

Company-specific risk refers to the risk that the management of the REIT does not do a good job (or just got unlucky) such that the company is not making money. Perhaps a major tenant declares bankruptcy and cancels their lease, so the company is earning less. Perhaps the company has not maintained its properties, so as leases come up for renewal they are forced to accept lower rents, or even lose tenants. Perhaps they have major investments in sectors that are contracting (like retail). As shareholders come to expect a dividend cut, the price of shares generally decreases. 

What REITs Should I Invest In?

As with stocks, there is no one size fits all answer. You have to consider your risk tolerance, the state of the market at the time you are buying, and the condition of the particular REIT at the time you are buying. Those listed above are a good place to start your research.

If you would like to invest in REITs without much research and in a manner that largely avoids company-specific risk, consider a REIT ETF or mutual fund. These are available from most of the large fund families and offer the advantages of high current income and diversification without having to follow the business of a REIT.

REITs are a good way to gain current income with some possibility of increasing value over time.