43 Are REIT’s Good Investments?
Welcome to episode 43 of the financially free journey podcast and I am your host, Courtney Dyer
Welcome, welcome everybody! This podcast aims to dispel the seemingly complex topic of personal finances, money management, debt, savings, investing and even retirement. If your new here, make sure to stick around because I take financial topics and break them down in a simple, easy to understand way so you can make the best money decisions.
Ok, so this week I received an email that I want to share with all of you which has inspired todays episode topic… the email said:
“Just wanted to reach out because I recently started my investing journey to financial freedom and your podcast has been an AMAZING resource. I’m so glad I found it and am super thankful for you passing on your wisdom!
As I research and become more educated, I started hearing/seeing the term REITs. After further investigation I’m understanding that it’s a real estate investment trust and is attractive because of the high dividend yields and there’s no tax implications on those dividends. But what’s the catch? Are there any cons to REITs? They’re probably riskier, yes. But as a new investor where would you recommend we research more about these and would this be a smart investment for a newbie? Specifically buying them in a Roth IRA. Thanks so much in advance!”
I love this question because this individual is really taking charge of their finances and are researching the best ways to gain returns on their money so they can reach financial independence.
I have touched on REIT’s in past episodes, but I haven’t actually dedicated an entire episode to this alternative investment vehicle. Traditionally, new investors think of investing their money in the stock market or if their interested in real estate, they consider buying rental properties to generate that consistent income from properties.
Now, this can be a great way to generate consistent income but being a landlord has a whole set of cons that come along with it. Many people will jump in head first to becoming a landlord because of that extra income that on the service seems pretty passive.
However, once you actually get into the thick of it, owning rental properties can end up being very costly, time consuming and not so passive after all.
Would it be great if there was a way to gets the pros of owning real estate but without the headaches of being a landlord? Well, that’s where REIT’s come into play.
In this episode, I am going to explain:
- What a REIT is
- The pro’s and con’s of a REIT
- When it would be good to consider investing in a REIT
Ok, so what is a REIT exactly? REIT stands for REAL ESTATE INVESTMENT TRUST and have been around since the 1960’s and were created by congress in order to give all individuals that opportunity to benefit from investing in income-producing real estate.
A REAL ESTATE INVESTMENT TRUST allows you as the investor to buy or finance properties the same exact way you would invest in other sectors of the stock market.
Here is an easy comparison- Think about REIT’s this way- In the same way shareholders benefit by owning stocks in other corporations, the stockholders of a REIT earn a share of the income produced through real estate investment, without actually having to go out and buy or finance property.
REIT’s are typically categorized into one of two categories: equity REIT’s or mREIT’s.
Equity REIT’s own a lot of different types of commercial properties like office buildings, shopping malls, apartment buildings, etc. Equity REIT’s get the majority of their income from the rent that is charged on the properties that are owned by the trust.
mREIT’s own a combination of residential and commercial properties and the “m” at the being of mREIT stands for “mortgage”. This can be an easy way to remember that mREIT’s base their real estate investments in the mortgage market. What that means is that mREIT’s buy mortgages on the secondary market and the majority of the income from the mREIT comes from the interest that is being charged on the mortgages that are being held in the trust.
So now that we know REIT’s are trusts that own some form of property and income is produced for the stockholders of the REIT from either rents or interest, let’s now talk about some more specific aspects of REIT’s, including the pro’s and con’s of investing in them.
Let’s first talk about the pro’s:
REITs offer investors the benefits of commercial real estate investment along with the advantages of investing in a publicly traded stock. The investment characteristics of income-producing real estate has provided REIT investors with historically competitive long-term rates of return that complement the returns from other stocks and from bonds.
REITs are required to distribute at least 90 percent of their taxable income to shareholders annually in the form of dividends. Significantly higher on average than other equities, the industry’s dividend yields historically have produced a steady stream of income through a variety of market conditions.
In addition to the historical investment performance and portfolio diversification benefits available from investing in REITs , REITs offer several advantages typically not found in companies across other industries. These benefits are part of the reason that REITs have become increasingly popular with investors over the past several decades.
REITs’ reliable income is derived from rents paid to the owners of commercial properties whose tenants often sign leases for long periods of time, or from interest payments from the financing of those properties.
Most REITs operate along a straightforward and easily understandable business model: By leasing space and collecting rent on its real estate, the company generates income which is then paid out to shareholders in the form of dividends. When reporting financial results, REITs, like other public companies, must report earnings per share based on net income as defined by generally accepted accounting principles.
In short, REITs over time have demonstrated a historical track record providing a high level of current income combined with long-term share price appreciation, inflation protection, and prudent diversification for investors across the age and investment style spectrums.
Ok, now that we have talked about all the pro’s when it comes to REIT’s, we now need to of course cover the con’s and risk that is associated with this type of investment.
Welcome back everyone and I hope you enjoyed that short sponsor break. Now it’s time to get into the cons of REIT’s.
I know that this was listed as a pro of a REIT but it can also be a con which is the fact that REIT’s are required by law to payout 90% of their income in the form of dividends.
The 90% payout often acts as a double-edged sword for REIT investors. For one, the rule limits future growth, particularly with the best REITs for income. Because the government requires the company to distribute 90% of its income for unitholders, little capital is left over for acquiring or renovating new properties.
In most cases, the federal government taxes dividends at a lower rate than ordinary income. Unfortunately for REIT unitholders, that dividend tax benefit does not apply to their REIT holdings. And because of this, the government defines these distributions as ordinary income. Which means investing in the best REITs for income will likely result in larger tax consequences.
Now, depending on your particular tax bracket and income level, this could push you up to a higher tax bracket which is something to consider and consult with a CPA and Wealth Advisor when and if you are seriously considering investing in a REIT.
Also, Property taxes usually become a REIT’s most significant tax concern. Owners have to pay all of the required taxes on properties. and in an environment of rising real estate prices, this likely means greater tax expenses and, possibly, could mean less income to distribute to unitholders.
If you’re an Investor in a REIT you might also want to lessen your exposure in high-property-tax states. For example, REITs that invest heavily in states like California, Illinois, New Jersey and Texas would likely feel the most effect.
Ok, at the beginning of the episode I told you we were going to talk about what a REIT is exactly, pro’s and con’s of a REIT and when it would be a good time to consider investing in a REIT.
As with any investment consideration, I have to tell you that you need to talk to a professional who can deep dive your income, taxes, investment objectives and time horizons….but generally speaking, you are going to want to consider a few things prior to pulling the REIT trigger.
First and foremost, have you eliminated all high risk debt? Meaning, all credit card debt, debt in collections, etc. Make sure your assets vs. liabilities looks good prior to making investment decisions.
Now, let’s say you don’t have any high-risk debt. If you have a qualified retirement plan through your employer, are you maxing out those contributions each year? This would be accounts like 401ks and 403b’s. The current limit is $19,500 a year for a 401k and most employers have a match program which is free money being left on the table if your not taking advantage of that already.
Another thing to consider here, depending on your tax situation you need to look into if traditional or roth contributions make the most sense for your particular situation.
Now, let’s say you have eliminated all high risk debt, your maximizing contributions into qualified accounts now its time to look at non-qualified accounts. This would be an investment account where you contribute after tax dollars to the account and invest funds. An example here would be a brokerage account or a roth IRA, like in the original question that was asked at the beginning of the episodes.
If your at this point in your investment journey, a key thing to remember is diversification. My number one piece of advice would be to consult with a professional so they can help you diversity your portfolio and keep it balanced.
If you’re a DIY type of person, you have to remember that diversifying your money is the name of the game. Your exposure to equities, which most REIT’s fall into this category, needs to be aligned with your investment objectives and your time horizon.
I mentioned this is a previous episode but a good rule of thumb is that you should subtract your age from 100 and that’s the percentage of exposure you should have in equities. So, I’m 32 and that would mean that 68% of my portfolio should be in equities.
REIT’s can be a fantastic addition to your portfolio and a good way to diversify your money. Make sure you do your research and then factor in the con’s that would personally affect you.
So to circle back to the original question, considering a REIT as a newbie to investing could be a great option. Check out the specific REIT your considering and look into the projected income and how that could affect your tax bill at the end of each year. Also check and see if it is a traded REIT or a non-traded REIT which can make a huge difference in how liquid the investment is and your ability to access your money if you should need it.
Before we end the episode, I want to highlight a recent review that was left by Rob Bejusca (hopefully I didn’t butcher your last name Rob) Rob said “ clear, concise and very informative. Thanks for the guidance! Keep up the great work”!
Thanks again for the review and if you haven’t already, make sure you go subscribe to the show, rate and leave an honest review. It really does help the producers and myself know exactly how to curate the episodes to be what you guys are looking for.
Thanks again for tuning in to todays episode. If your not already, make sure your following us on Instagram @financiallyfreejourney where you will get more tips and motivation to help you on your financially free journey…until next time!