Real Estate Investment Trusts (REITS)
Real Estate Cash Flow, REITs, Great Addition to Portfolio) (MPW, O, STOR, etc)
I would sure like to invest in real estate, but can’t even hammer a nail or unclog a toilet!
This is a common refrain heard from many that fear jumping into real estate investing due to the high level of management required. But those nice stable investment returns and appreciation of capital are sure nice, it is like the demand cannot keep up with supply when it comes to real estate. But if you do not want to respond to maintenance calls, have you heard of a REIT (Real Estate Investment Trust)? This article will talk all about REITs and compare them to traditional "hands on" real estate investing.
I write a lot about real estate because I have a passion for it as a thing and as an investment vehicle. It may have something to do with my arts background, but I enjoy a well designed and well maintained property. Think about how essential real estate is to our modern lives. It keeps us safe, healthy and provides a platform for some of our greatest family memories. It is the grocery store, mall, coffee shop, warehouse, office complex, fast food joint, pharmacy, etc. Real estate in general is an excellent asset class in many ways. But it is important to consider all the pros and cons of the different ways to invest in real estate. In this article we focus on one that can be very easy to enter and easy to manage, high quality real estate investment trusts, or REITs.
What is a REIT?
Slow and steady often times wins the race!
A REIT is a company that owns and in many cases operates income producing real estate. An investor can buy shares of these companies. In other words, a REIT is a pool of properties and mortgages bundled together. The company offers shares of these combined assets in the form of a security or stock that an individual can buy into. There are all kinds of REITs that specialize in different types of real estate including office/commercial, apartment buildings/housing, hospitals, shopping centers, hotels, etc. REITs were invented as a real estate vehicle under a Public Law signed by President Eisenhower. REITs give all investors access to large scale real estate development investing.
IRS Rule on Income
One really neat feature of REITs is that IRS rules require the company to pay out 90% of their income back to share unit holders. This is typically in the form of a dividend. Dividend income is one of several strategies Money Vikings are harnessing to reach FI, so this makes REITs an ideal investment vehicle.
REIT vs. Hands On Real Estate Ownership
We are going to run some numbers and look at the pros and cons of owning/investing in REIT's vs actual hands on real estate investment ownership. The result may surprise you:
Real Estate Investment
Let’s say you invest in a $500,000 investment property (single family home) in a nice middle class neighborhood. You put $100,000 down and finance the remaining $400,000. In this scenario it is important to remember that your actual investment is $100,000.
On a $400,000 mortgage the total cost of principle, interest (4-5%), escrow for taxes, would be about $2,500/month
Add another $100/month for landscaping and another $100/month for deferred maintenance.
The house would cost about $2,700/month in expenses.
BOTTOMLINE: If you look at the rental market and let’s say the property would rent for about $3,100/month. So a person would be looking at a $400/month cash flow “profit”.
Now, keep in mind that this investment takes a lot of hands on care and feeding: There will be maintenance calls to respond to at off hours. Changes of occupancy to manage, advertising, screening tenants, contracts to negotiate and sign. Long term maintenance to manage. Minor and major repairs, etc.
But on the other hand, over many years you will be building equity in the property. So as the $400k note is drawn down and the price appreciates at 3-5% annually, the value of that investment can grow from the original $100k to $200k, $300k, etc.
Real Estate Investment Trusts (REIT)
Let’s analyze a $100,000 investment in a REIT. A very popular and strong REIT is the company Realty Income, ticker symbol “O” which we have written about before. With $100,000 you could by 1,538 shares of “O” at $65/share. The stock offers a 4% dividend yield. One really neat thing that I love about “O” is that they pay the dividend monthly, which makes it feel like a traditional real estate investment. Each share returns .221/share per month.
BOTTOMLINE: .221 x 1,538 shares = $340/month cash flow
All this with no calls in the middle of the night due to a leaky roof!
As you can see from this simplified example, the investment in a high quality Real Estate Investment Trust can offer some comparable returns and cash flow. The REIT investment certainly has far less “headaches” in terms of day to day management. All investing holds some level of risk. The company could tank and the shares lose value. On the other hand, investing in physical real estate you manage has its fair share of risks. A major repair could certainly set you back at almost any time.
I like working with both REIT’s and traditional real estate. But for someone that does not want to deal with Tenants, contracts, repairs and hands on management, REIT is the way to gain exposure to the real estate sector. And looking at some of the initial numbers, may provide many of the returns and pure financial results. Ideally the value of the REIT shares will rise just as the underlying value of any real estate asset will rise.
Here are a few examples of quality top of the line REIT’s that many profit from:
Vanguard Real Estate ETF (VNQ)
You know I like thematic ETF's as a way to profit from macro trends and growth. Vanguard's Real Estate ETF is an excellent way to gain exposure to top quality REIT's and capture some of the yield. You gain access to quality REIT's such as:
Vanguard Real Estate II Index Fund2American Tower Corp.3Prologis Inc.4Crown Castle International Corp.5Equinix Inc.6Public Storage7Digital Realty Trust Inc.8Simon Property Group Inc.9SBA Communications Corp.10Welltower Inc.
Medical Properties Trust (MPW)
From the Motley Fool:
Medical Properties Trust (NYSE:MPW) gets a lot of upside out of being a real estate investment trust (REIT), not least because it is investing in a market that nearly everyone expects to grow: healthcare spending. The company buys hospitals and leases them back with long-term, triple-net leases.
In 1970, healthcare costs were responsible for 6.9% of the gross domestic product in the U.S. By 2019, that percentage had risen to 17.7%. Of those numbers, hospital and physician services represented half of the spending. According to data from the Centers for Medicare and Medicaid Services, the compound annual growth rate (CAGR) for healthcare spending is expected to be 5.4% through 2028, reaching $6.2 trillion by then, with healthcare expenditures taking up 19.7% of the GDP in 2028.
Retirees can benefit from that trend by investing in Medical Properties Trust.
STORE Capital “STOR” (A Berkshire Buffett REIT)
Net lease REITs have high and consistent income generation, coupled with moderate growth and low risk. What does Triple Net Lease mean, it basically means the tenant pays the taxes, repairs/maintenance and insurance on the property, in addition to rent. STORE Capital is one of the best performing net lease REITs around.
"Net lease" or "triple-net" are commonly-used terms to describe freestanding retail property investments. Who owns the Dollar General convenience stores, CVS pharmacies, or even Chevron gas stations? You can own a small slice of the action if you own shares of REIT STOR. Added bonus, STOR is a Buffett Berkshire stock, so you know it has been pretty well vetted by the master himself.
Realty Income “O”
I am a long term owner of O stock, Realty Income. This is another strong REIT. Realty Income is a high-quality income vehicle for investors with a moderate risk tolerance. A U.S. recession may be in the cards, exposing income investors to growing downside risks, but this is still a steady long term play. Here is more information about Realty Income "O".
Simon Property Group & Medical Properties Trust
Other strong REITs to consider are Simon Properties Group, Medical Properties Trust (highlighted above) and Stag Industrials. Those are on our Christmas list this year. Simon (SPG) owns and operate high end malls. Of course they are steering themselves through the storm at the moment, but this has the potential to be a nice long term investment when the waters have calmed again. Medical Properties Trust (MPW) and Stag Industrials (STAG) are plays that work in any environment. Medical properties are probably immune to whatever is happening in the world and STAG owns the distribution centers where all those Amazon boxes are shipped from. *As always, this is not investment advice for any single individual. This article is for informational purposes only and only represents the opinions of the author.
National Retail Properties “NNN”
Another widely touted and strong REIT is National Retail Properties. The stock may be a bit high, but it is deemed another good long term hold. Properties remain highly liquid and many are selling for very low cap rates. Liquidity, dividend growth, and dividend coverage all remain rock solid and the company continues to improve efficiencies. NNN once again showed why its long-term shareholders sleep well at night. While occupancy dipped slightly and signs of growth headwinds have appeared, the company continues to operate effectively, which will fuel dividend growth in the future. National Retail Properties is a buy again. The commercial property REIT has excellent portfolio and dividend coverage stats.
Federal Realty Investment Trust "FRT" (Dividend King!)
FRT has increased its dividend for 51 years in a row, making it the only Dividend King REIT. Federal Realty continues to grow in spite of a challenging environment for brick-and-mortar retail, as it continues to focus on the highest-quality properties and locations. The beauty and simplicity of competition. With total expected returns exceeding 10% and annual dividend increases, FRT is a buy for dividend growth investors.
In this article you can see that there are alternative ways to be a part of the real estate investing world that do not involve plunking down huge amounts of capital, taking out a loan, doing property inspections, screening tenants, unclogging toilets, and spending a fortune on a new HVAC system when the old one dies. In fact, the cash flow that can be generated from a sizable investment in high quality REIT's can spin off some significant income. REIT's are a great alternative that have now stood the test of time and can be an ideal vehicle for those searching for passive income. Yes, the industry will continue to manage and weather disruption, but that has always been the case as consumers priorities and desires shift. A good company anticipates and prepares for these changes and shifts.