Today we will look into REITs an alternative to property investing. REITs (Real Estate Investment Trusts) can be used as a means to diversify your investment portfolio into another asset class without direct investment into property.
REITs are a little like ETFs (Exchange Traded Funds) and index funds in that they contain a parcel of the underlining assets within them. This helps to reduce the risk of owning a single property as you are diversifying into many properties. If a single property is unprofitable it will be counteracted by the other profitable ones and will not wipe you out. This can be compared to owning a single stock in 1 company versus a pool of 500 companies in an ETF like the S&P500 index.
Many Australian’s are already homeowners. According to a recent census a whopping one-third of Australians own their home outright. A further one third are in the process of paying down a mortgage with significant equity tied up in it. This may mean that a large percentage of your net worth is already tied up in the real estate sector. Adding an investment property to your portfolio may tilt you too heavily towards the real-estate sector and in this case REIT’s can offer an alternative to help with your asset allocation.
Advantages of REITs
One of the main advantages of REITs are the barrier to entry is very low. To purchase traditional real-estate you would likely require a large initial deposit. This could be 10% to 20% as a down payment. If you were looking at an apartment building or commercial real-estate this could equate to millions of dollars and not affordable for most investors.
Another advantage of REITs is the simplicity. The trust will arrange the property maintenance, purchasing of additional investments, collecting rents and all the work involved in property management. Yes this will come at cost and you could potentially produce better returns investing directly into real-estate vs a REIT.
Requirements of REITs
REITs are required to pay out most of their earnings as dividends in order to get better tax treatment. When REITs calculate their taxable income for the year they are required to have payed out at least 90% as dividends to shareholders. REITs are also required to have at least 75% of their assets invested in real-estate. These rules apply to any publicly traded REITs, privately traded REITs or public non-traded REITs.
Due to the fact that REITs pay out most of their profits in dividend distributions there will be less capital appreciation. The asset will generated more dividend income. You will need to consider this as part of your overall strategy as dividends will need to be declared as part of your taxable income.
Types of REITs
REIT’s like other investment funds come in many shapes and sizes covering all different sectors of the Real Estate market. Below I will covers some of the more common real-estate sectors covered by REITs.
– Residential REITs
Residential REITs contain various forms of residencies such as single family homes, apartment complexes, student housing, manufactured homes, low income housing. They then rent these properties out to tenants. There are also sub categories of Residential REITs that focus on these specific forms of residencies.
– Retail REITs
As the name suggests Retail REITs contain retail properties such as shopping malls and freestanding retail properties. Income is produced by renting out the shop spaces to tenants. Be aware that this sector is under pressure due the continuing shift to online sales.
– Office REITs
Office REITs invest in office buildings and office space including shared office space. Income is derived from tenants and they usually have long term leases. This sector has also been put under pressure due to COVID and the ability for staff to work from home.
– Healthcare REITs
Healthcare REITs primarily invest in real estate used for retirement homes, nursing facilities, medical centers and hospitals. Generally leases are long term and government reimbursements help fund many of these facilities.
– Industrial REITs
These REITs invest in properties such as warehouses, distribution centers, manufacturing facilities, research and development and similar commercial real estate. Unlike office space and retail space demand has been increasing in this sector due to the e-commerce boom. Leases are generally long term.
The above mentioned REITs can also have concentrations in different geographical locations and this should be taken into consideration when selecting a REIT.
There are many options when it comes to investing in REITs. You can concentrate on sectors. You can concentrate on geographical locations. Or you could concentrate on industries. There is also the option if you want additional diversification to purchase ETFs that contain a bundle of different REITs within them.
I would love to hear about your experiences with REITs!
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