Investing in REITs In Order To Quench Your Thirst For Real Estate Income
Update on this post regarding REITs investments for physicians. I have come from the future to update this post – 2021 – and it’s strange that some of these investments no longer exist.
It’s only been 5 years and there has been a lot of moving and shaking. Doesn’t mean that REITs are a bad investment but worth keeping such changes in mind.
My personal REIT portfolio is still performing quite well – no major complaints.
The reason I titled this ‘for physicians’ is because we become the targets for a lot of speculative investments. With such a solid income, we generally don’t need to take a lot of speculative risk.
Real Estate Investments
There is a lot of talk about real estate recently because they are at an all-time high (as of 2016). New investment methods are popping up online for those interested in investing in real estate. I decided to do a little research on good old REITs and see what I could come up with, whether it’s still something worthwhile to invest in.
So why real estate? The great thing about RE is that it’s a hard (physical) asset and not a security. RE is a building or land and it serves a purpose, you can live on/in it, store shit in it etc even if its value drops. A home you purchased for $500k that earns you $2,700/mo of rental income will likely continue earning you $2,700/mo of rental income even if its value drops down to $350k for a period of time.
Adding RE to an investment portfolio of stocks and bonds also adds diversification. These 3 investments generally don’t have a high correlation. Which means that if you are living off of your investments and your stocks go down then at least your RE investments may provide some stability until the time that stocks recover.
What is a REIT Investment?
It’s a product designed to be like a mutual fund. The majority of them have a ticker symbol and they can be traded like a mutual fund. There are a total of 1,100 unique REITs out there though about 200 are traded on major stock exchanges. Examples include FSRVX, SCHH, FTY, IYR, VGSIX, WREI.
The US started introducing them in the late 60’s, early 70’s. Since then they have done fairly well as an asset class. Currently (2016) 30 other countries have REITs which are traded on stock exchanges.
The good thing about REITs is that they are fairly strictly regulated (then again supposedly so was the mortgage industry). The majority of their revenues must come from actual real estate investments and not some other random investment product.
If you want to learn how to analyze a specific REIT funds I would get some info here and go from there.
REITs generally either invest in real estate or in mortgages. RE could be hospitals, shopping centers, residential housing, hotels etc. Mortgages are self-explanatory. REITs are therefore broken up into 2 major categories, equity REITs or mortgage REITs or a hybrid of the two.
Individual Property vs REIT
This post is more about REITs than an individual real estate investment. I could compare an actual real estate with a physical address to a REIT but that’s like comparing the business you own to several stocks you own of various public businesses. There is less diversity in a business or in a single RE but you have more control over it. A REIT investment or a set of stock investments are possibly more diversified but will likely also have a smaller margin of profit.
For those who own their home or perhaps some rental property the decision of investing in REITs should be made according to one’s asset allocation. If your primary residence is a paid off home then it is potentially an actual investment. If you still owe a lot on it then it’s more a liability, not so much an asset.
I’ve talked about a home being more a liability rather than an asset. A paid off home might be different. And every individual can leverage their primary residence uniquely to their circumstance. If you use it to store a ton of goods then you could be protecting yourself against inflation by using those goods in the future when you purchased them at a low price in the past. If you rent out a room then you could be generating income. If you maintain the property well and sell it at the right time then you could capitalize on its appreciated value.
Others use their home to raise their kids in through homeschooling or they entertain themselves and friends there which can saved thousands a month. Lastly, some will homestead on their property and farm their backyard/land in order to provide food for their family.
I got a bit off-topic, back to REITs. Another attractive aspect of REITs is that they have higher dividends than your average stocks/bonds. There is always a fee when owning a REIT (as far as I know) which is generally expressed as an expense ration. The specific funds I own has an expense ration of 0.26%, fairly low.
REITs And Stocks
There is a lot of talk about how REITs don’t correlate to stocks which is the reason it helps an investor diversify their portfolio. But I decided to pull up a chart of VGSIX and S&P 500 Index on the Vanguard website and I’m no genius but those squiggly lines sure look like they are correlating when looking at the historical numbers.
Why am I mentioning the ‘correlation’ thing? Because investing is also about simplification. If you think that a certain asset moves in sync with another investment option then why the fuck own both of them?
The only thing I will add to this argument is that we are looking at things historically. And yes, historically it appears that there is some decent correlation between stocks (equities) and REITs but it doesn’t mean that this same correlation will continue in the future – that’s the part that make me want to invest in REITs.
The chart below shows a common Vanguard REIT and how it has moved in comparison to the S&P 500 from 2006-2016.
I analyzed a few historical investment charts and came up with some amateur conclusions.
It appears to me that most years there is a decent correlation between the 2 as well. Sure, there is more variability in the stocks graph but the general trend is the same. I couldn’t find a graph that goes up to 2016 otherwise you would see that from 2011-2016 there is again a decent correlation between the two.
REITs And dividend payouts
Another benefit of this investment is that it has higher dividends than your average stock portfolio. So if we compare a broad mutual fund to a broad REIT fund the REIT will pay out more every year in dividends, somewhere in the 3-4% range from what I researched but I see reports of up to 10% (couldn’t find any funds that pay that).
So if you own $100k worth of REITs then you can expect to make ~$4k every year in dividend income alone. You would pay ordinary income tax on this income which is a bit of a disadvantage – if your federal income tax rate is 35% then you would lose more than 1/3rd of your profits to taxes. Stocks, however, have different kinds of dividends which are taxed at a lower rate but then again they pay out only around 2% a year in dividends.
In Summary
REITs are just another way to get into real estate investing.
If you prefer to be more hands-on then buying your own individual property might be the best option for you.
I find it to be a good way for me to get exposure to real estate and diversify my portfolio. I currently hold only about $20k worth of REITs in my IRA but would consider investing into it in my taxable account as well, we’ll see.