Cons Of Reit Investing
What is REIT investing, if not for another way to diversify your portfolio? As an investment, REITs are not without their own caveats, however. Along with the pros, there are cons, and they are worth paying attention to. Here are some of the cons of investing in REITs youll want to consider before making any big decisions for yourself:
- Limited Growth Potential: Their upside is limited by the very thing that makes them attractive to investors: dividends. REITs, therefore, have less money to reinvest in their own company, and are essentially their own worst enemy its very much so a double-edged sword scenario.
- Tax Exemptions: Some of the dividends shareholders receive are taxed as ordinary income, whereas most other dividends are taxed at a lower rate.
- Interest Rates: The performance of REITs are inherently tied to interest rate trends. When rates increase, they eat into the profit margins of REITs. Whats more interesting, however, is that interest rates usually rise when the economy is strong enough to handle them.
- Susceptible to Market Fluctuations: While the performance or REITs are generally tired to the real estate market, they can be influenced by volatile market fluctuations, from time to time.
Consider How Much You Can Afford To Invest
As with any investment, it’s important to know how much you can afford to set aside and put at risk. While real estate experiences different fluctuations from the stock market, there’s still a risk of losing money on your investment.
Also, if you’re planning to invest in a REIT that isn’t publicly traded, you’ll need to think about how much money you can reasonably lock up for a long period of time since you can’t be sure how liquid your shares will be in the event that you want to sell.
Finally, while REITs can help diversify your asset allocation, you’ll still want to make sure you’re investing in other asset classes, such as stocks and bonds, to make sure you’re not putting all of your eggs in one basket.
Investing In Reits For Beginners
A REIT is a real estate investment trust that owns and operates real estate and real-estate-related assets such as mortgages, land, property, and more. Investors who want to invest in real estate may wish to purchase shares of a REIT to diversify their portfolio.
Before you invest in REITs, be sure you understand what they are, how they work, and whether they are a good fit for your portfolio. Heres everything you need to know about investing in REITs.
Read Also: Best Opportunity Zone Funds To Invest In
How Do I Invest In Reits
Your approach to investing in REITs depends on what type of investor you are. Some investors may want to invest in an exchange-traded fund or mutual fund that tracks a broad-based REIT index rather than investing in individual REITs. You can buy and sell REITs on your own with a Schwab One® brokerage account or call us at 877-566-0054 to talk to an experienced specialist about whether REITs are right for you.
Reit Vs Real Estate Crowdfunding
Real estate crowdfunding has become a popular source of real estate investment as technology has allowed regular investors access to this type of real estate transaction.
To understand how a REIT differs from crowdfunding, its important to understand what crowdfunding is. The simplest example of crowdfunding is sites like Kickstarter or GoFundMe.
These sites ask large groups of people to invest in a business idea, non-profit, or other types of project. Real estate crowdfunding functions in the same way.
If someone wants to invest in real estate but does not want to own or manage a property, or does not have the capital to buy one on their own, they can use a crowdfunding site to invest with smaller sums of money and less hassle.
The investors earn money from the profits of that specific venture. That could be from rental income, the sale of a new construction property, or sale of a rehabbed home.
If this sounds similar to residential REITs, that is because it shares many of the same characteristics. That said, the primary difference is that when you purchase a REIT you are purchasing shares in a company that owns multiple properties.
In the case of a REIT fund, you wind up purchasing shares in thousands of properties. With crowdfunding, you are exposed to that single property you invested in.
Don’t Miss: How Do I Invest In Nike Stock
What Is An Appropriate Allocation To Reits
The answer will vary based on each investors goals, risk tolerance and investment horizon, but here are some key insights that can help:
Multiple studies have found that the optimal REIT portfolio allocation may be between 5% and 15%.
David F. Swensen, PhD, noted CIO of the Yale endowment and author of Unconventional Success: A Fundamental Approach to Personal Investment, recommends a 15% allocation to REITs for most investors.
Further insight comes from Chatham Partners’ research which found that advisors recommend allocations to REITs in the range of 4% to 12% irrespective of the client’s age from early career to in retirement.
Connection To Tangible Property
Some investors believe that REITs should not be placed together with other stocks because they represent a tangible property. REITs represent shops filled with useless junk and condos filled with single people desperately looking for dates, which makes them different from most other conventional stocks like Apple, ExxonMobil, or Microsoft.
But the fact is that REITs are stocks, and they share a lot of commonalities with stocks. If there is any difference between REITs and other stocks, it should be in terms of dividends and lack of market correlation, not their tangibility.
Also Check: Best Investment Apps For Small Investors
Balancing Risk And Return
Though diversification protects you from devastating losses, it also costs you in average annual returns. That’s because risk and reward go hand-in-hand in the financial markets. So anything that reduces your risk will also reduce your return.
Give yourself permission to take a little risk, unless you’re close enough to retirement that the additional security is particularly valuable.
Some people argue that the rule of thumb is too conservative, because it suggests that a 50-year-old, who likely has another 30 years to invest, should have a 50-50 stock and bond mix. These people suggest a better rule of thumb is to subtract your age from 110.
The best answer is one that’s geared to you. If a little extra risk won’t keep you up at night, this modified rule of thumb can work. But, if it will cause you distress, stick with the original rule of subtracting your age from 100, even if it isn’t as lucrative. You’ll save money on antacids.
How To Make Profits From Reits
Your total return for REITs merges two things: dividends and appreciation of share price, no matter your investment strategy. These are two ways investors make money on REITs. Dividend yields from REITS are generally higher than average. This is because investors are expected to get paid at least 90% of taxable income, which makes REITs yield averages greater than returns from the stocks of the S& P 500.
Investors tend to choose REITs with the biggest dividend yield because they look like the best REITs for income, but we must be careful in following this approach. Historically, The highest yielding REIT has not always been the highest returning investment over time.
Normally, the higher the yield, the more terrible the financial situation of the firm. A REIT with an above-average yield most likely increased its yield to lure investors because the firm was not as strong financially as its rivals.
Dividend yields fluctuate across the REIT sector, so income seekers have to ensure that they look for REITs with safe dividends that have the capability of beating market averages. Over time, REITs that have continued or raised dividends during difficult times met by current cash flows and have sustained market demand could most likely affect a solid REIT consideration.
You May Like: How To Invest Without A Financial Advisor
Kinds Of Real Estate Investments
Debt Financing
In debt investing, the donor gives money to a borrower at an interest, just like we do with the banks. There are various varieties of projects that may need funding at any given time. With marketplace lending, you can as well render short or long-term loans to real estate developers looking for money to finance a residential property: shopping malls, rehabs, commercial property development, apartment buildings, other varieties of real estate investments. If you lend money for a project, you can anticipate receiving monthly dividends as the borrower repays the loan.
Equity Financing
Equity investments are slightly different. An equity investment in real estate implies you own a part of the property. Just like with debt investments, you can invest in various types of real estate as you build your equity portfolio. If you hold equity in a real estate asset, then you may or may not get a yield on your investment depending on whether the property sponsored accomplishes its goal.
For example, if you put $100,000 into developing a residential complex that is never completed, you will not get any yield on that investment. However, if the residential complex is completed and then traded at the end of the investment period, you and other investors in that project will earn a portion of the sale interests based on how much equity you bought. In some cases, as in rental units, you may be entitled to continuous dividends as well.
Learn More About Reits And Investing
If investing in real estate by buying a REIT sounds appealing, the next step could be to take a more in-depth look at specific REITs. The National Association of REITs has a directory of publicly traded REITs that may be a useful starting point.
If you find a REITor REIT fundthat aligns with your goals and risk tolerance, it could be a good addition to your portfolio. However, it might still be best to speak with a financial planner who can assess your specific situation and offer you personalized advice.
Before making any investments, make sure your existing financial obligations are taken care of. This includes your retirement plan and emergency fund. Your debt should also be considereddue to interest costs, you might be better off paying down debt before making new investments.
Recommended Reading: Difference Between Broker Dealer And Investment Advisor
Past Performance Of Reits
Real estate has historically performed well as an investment type, and the same can be said for REITs. The success of REITs over time is typically measured by the Financial Times Stock Exchange Group NAREIT Equity REITs Index. Looking at numbers over the decade, REITs have experienced an average annual return rate of 9.5 percent. This performance is impacted by several economic and political factors, such as interest rates, job growth outlook, treasury yield, and more. Each of these components helps REITs to remain level through periods of economic downturn. Even over the course of the last year, the annual returns for REITs have increased by roughly 31 percent.
Historical Returns Of Reits
Real estate investment trusts are historically one of the best-performing asset classes available. The FTSE NAREIT Equity REIT Index is what most investors use to gauge the performance of the U.S. real estate market. Between 2010 and 2020, the index’s average annual return was 9.5%.
More recently, the three-year average for REITs between November 2017 and November 2020, 11. 25%, was well above both the S& P 500 and the Russell 2000, which clocked in at 9.07% and 6.45%, respectively. Historically, investors looking for yield have done better investing in real estate than fixed income, the traditional asset class for this purpose. A carefully constructed portfolio should consider both.
Recommended Reading: Can Indians Invest In Us Stock Market
Pros And Cons Of Reits
REITs offer several advantages to investors, from their attractive record of long-term growth to their hefty dividends, and they remain a favorite among investors looking for income.
Nearly all investors would benefit by exposure to REITs, says Morris Armstong, financial strategist and founder of Morris Armstrong EA, LLC in Cheshire, Connecticut.
But like all investments, REITs present certain drawbacks, too. Here are the major advantages and disadvantages of this asset class.
How To Invest In Reits In 5 Steps
Recommended Reading: How Does Fisher Investments Rank
Limited Correlation To The Broad Markets
An index of U.S. REITs has shown a correlation of 0.4 with the S& P 500 over the past 20 years. This implies that the price of an S& P 500 index fund and the share price of a REIT index fund has moved in the same direction with other market stocks considerably less than half the time. The REIT index has nearly no correlation to bonds.
Holding around 20 percent REITs in your portfolio over the past 20 years, no matter whether your portfolio was made up of mostly stocks or bonds, would have both increased your returns and reduced your financial volatility. Investing in REIT is the easiest way to beat inflation and preserve your capital.
Average Returns Of Reits
REITs have historically been one of the best-performing asset classes available. Most investors look at the FTSE NAREIT Equity REIT Index to measure the performance of the U.S. real estate market.
For example, between 2000 and 2020, the indexs average annual return was approximately 12%, well above the S& P 500, clocking in at 8.57%.In fact, over that period, REITs were the best performing asset class in the U.S., more than doubling the rate of return delivered by bonds.
Indeed, investors looking for yield have done better investing in real estate than in fixed income . However, a carefully constructed and diversified portfolio should consider both.
In short, the right way to think about REITs versus bonds is according to your total asset allocation. REITs can account for a certain amount of the equity portion in your portfolio. Still, at the same time, bonds should be owned separately since they serve as capital preservation during a recession and in a bear market.
Also Check: What Does Fixed Income Mean In Investing
Special Status Among Financial Pros
Whether they essentially use style investing, sector investing, or astrology charts and tea leaves, the widespread majority of wealth advisory firms all identify REITs as a separate asset class and tend to add it to most peoples investment portfolios. A lot of people ask, Is that differentiation rational and just? It is.
If REITs deserve that differentiation, what makes it unique compared to some other industry sectors, such as utilities and energy? Because, if you look at them, both utilities and energy have lately shown less correlation to the S& P 500 than have REITs. Dont they merit their part of the portfolio pie?
But one likely justification for this classification is that REITs are regarded as a separate asset class. This may be because REIT marketers are savvier than the marketers of utility stocks. Apart from having a low correlation to the bond market, they have also shown to be able to return exceptionally high dividends.
You Can Use Some Retirement Accounts To Invest In Reits
According to Jhangiani, alternative investment options have been becoming more accessible through retirement accounts, including when it comes to REITs. You can invest in publicly-traded REITs through retirement accounts, including traditional and Roth IRA’s.
When it comes to 401 plans, though, it’ll depend on what is available through your employer’s plan. Many employers only allow you to invest in a target date fund through your 401. But you can always contact your company’s benefits team to get some clarification on whether or not you have the option to invest in REITs through your 401 plan.
You May Like: How To Invest In A Specific Company
How To Avoid Fraud
Beware of anyone trying to sell REITs that are not registered with the SEC. You can confirm the registration of both publicly traded and non-traded REITs through the SECs EDGAR system. This database provides free public access to corporate information, allowing you to research a public companys financial information and operations by reviewing the companys filings with the SEC.
Note: Before investing in REITs, consider consulting your tax adviser. Additionally, check out the broker or investment adviser who recommends purchasing a REIT.
The Keys To Assessing Any Reit
There are a few things to keep in mind when assessing any REIT. They include the following:
According to the Securities and Exchange Commission, a REIT must invest at least 75% of its assets in real estate and cash, and obtain at least 75% of gross income from sources such as rent and mortgage interest.
Also Check: Investment Company Of America Class A
