iStock-1900503626 (1) 2.jpg - updated Real Estate Investment Trusts How we structure a bond portfolio will greatly depend on the risk tolerance and time horizon for the client – and current yields available in the marketplace.
Real estate is an asset class that investors can use to further diversify that provides plenty of upside growth potential and income too. The easiest way to gain access to real estate, without having to become a property owner outright and manage and maintain buildings, deal with tenants and collect rent, is through real estate investment trusts (REITs). REITs trade daily like stocks on major exchanges and the sector includes rental real estate, office buildings, malls etc. There are plenty of advantages to owning REITs so let’s examine the most obvious reasons to include them in your portfolio.
Advantages
- REITs offer access to real estate ownership that you might otherwise not be able to own. Through a publicly-traded REIT you can own a piece of shopping malls, residential real estate, or apartment complexes in a certain region in the U.S., or even abroad.
- No management or maintenance duties. Owning a REIT allows you to have access to rental real estate without the hassles of dealing with tenants, upkeep, management, tax and depreciation considerations, illiquidity etc.
- REITs are required by law to pass through 90% of their rental income to you. As a REIT owner you not only have an investment that can grow over the years, but you also receive excellent cash flow.
- REITs have historically offered some diversification away from stocks. In deep bear markets REITs can become highly correlated to stocks (when many asset classes decline together), but generally they will provide some diversification, which can help smooth out the returns of the entire portfolio.
- REITs can offer access to diverse real estate sectors. Owning an index of REITs or a broad-based individual REIT portfolio allows you to have access to very diverse real estate sectors that would otherwise be impossible. Again, you can have access via mutual funds, ETFs, or individual securities.
- REITs typically offer higher yields than stocks. Since REITs are required to distribute 90% of their income to shareholders, they typically offer higher yields than most stocks.
- REITs offer stable, consistent income. REITs offer steady income and many have a history of raising dividends consistently.
Disadvantages
- Not enough diversification away from stocks. In times of illiquidity or during a bear market, REITs can be highly correlated to stocks.
- REITs, like stocks or bonds, can become overvalued. When REIT income is low relative to prices, be careful. While REITs are usually considered a fairly high yielding asset class, if prices have increased dramatically and yields haven’t kept pace, there is a good chance REITs are overvalued and due for a correction. Furthermore, the annual income from REITs is insufficient to protect against deep price declines during bear markets.
- Income from REITs doesn’t receive a preferential tax rate. REIT income doesn’t fall under the same qualified rate as stock dividend income. REIT income is typically taxed as ordinary income – same as bond interest, which is usually much higher than the rate paid on qualified stock dividends.