Stocks

Five Reasons To Be Bullish On REITs

I’ve been investing in real estate for a very long time.

From the home I live in, to property companies, to physical investment properties.

But one of my favourite real estate investments is real estate investment trusts (REITs).

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REITs were created back in 1960 to allow regular everyday investors to invest in large portfolios of income-generating real estate.

U.S. President Dwight Eisenhower approved the legal framework for a real estate structure that’s similar to the mutual fund structure for investing in stocks.

REITs have since spread around the world as an increasing number of jurisdictions create their own REIT legislation. In Asia, Australia has a large REIT market, with REITs available there since the 1970s.Other relatively developed REIT markets include Japan (since 2001), Singapore (2002) and Hong Kong (2005).

What is a REIT?

A REIT is a company that owns a portfolio of income-generating real estate. The properties owned by REITs vary hugely – they can be commercial (i.e. offices), retail, residential or industrial, and can even include hotels, hospitals and forestry.

REITs don’t even necessarily need to own real estate. Mortgage REITs (MREITs) own bundles of commercial and real estate mortgages, for example. In the case of MREITs, an investor is buying a portfolio of the mortgage debt or mortgage securities.

Just now, I’m going to focus on REITs that own bricks and mortar real estate – also known as equity REITs.

There are lots of good reasons for you to own REITs… here are five:

1. Earn income

By law, REITs have to pay out nearly all of their taxable income to shareholders in the form of dividends. Whilst the percentage of income that must be paid out varies depending on the specific REIT country jurisdiction, it’s usually at least 90 percent.

These REIT dividends are all backed by rents. The REIT owns (and often manages) portfolios of underlying real estate. It collects the rent and pays out nearly all of that income to you. And what’s more, it has to, by law.

In Asia-Pacific, there are REITs holding portfolios of quality properties paying 5 to 7 percent or more in dividends. This is attractive in a world of persistently low interest rates.

2. REITs are tax efficient

As an investor in a regular listed stock, by the time you get that dividend cash into your brokerage account, it’s been heavily taxed.

Dividend income from regular listed companies is taxed twice. Firstly, it is taxed at the company earnings (or profits) level. In the U.S., for example, whilst the final effective corporate tax rate varies from company to company, the headline tax rate is 35 percent.

The second level of taxation is at the dividend itself, which, depending on your circumstances, can be up to 20 percent.

 

But REITs only get taxed at one level, depending on the REIT jurisdiction. Most of the time, this means that REIT income is tax exempt, so long as they pay a minimum of 90 percent of their profits to shareholders. In other markets, the dividends received by the investor are tax exempt, if the REIT has paid tax on its income.

Either way, this makes REITs much more efficient for us as investors… we only get taxed once.

3. Be a landlord without the stress

I am a huge advocate for investment real estate ownership. But I know how much of a hassle it can be sometimes.

Deadbeat tenants who don’t pay the rent or cause damage, the costs of renovations and refurbishments between tenancies, midnight phone calls about clogged sinks… there are a lot of downsides to being a landlord.

REITs allow you to be an owner, albeit a small one, of a portfolio of rent-generating real estate – without having to deal with any of the aggravations that can accompany being an individual landlord. None of the tenants from your REIT portfolio will be calling you at 4 am on a Sunday morning after a kitchen pipe has burst.

4. Own the best real estate

As an individual, it’s unlikely any of us will ever be able to buy a prime downtown office building or a high-end retail mall in New York or Tokyo.

But REITs allow us access to some incredible real estate that we’d otherwise have no chance of ever owning ourselves.

For example, if you do some research and come to the conclusion that you like the Singapore office market or the U.S. industrial market, you can take a position in these markets by buying a REIT. Because most REITs focus on one kind of real estate, and sometimes in one city, it gives the investor the opportunity to take a position in that market for a small amount of money.

5. Add some predictability to your portfolio

Rental income and property management costs are relatively predictable over the short to medium term. Lease terms are anywhere from two to 10 years in many commercial markets. That means as investors, our income outlook is stable – we don’t need to worry too much about earnings in the same way we do about our normal equities.

REITs also exhibit low beta. Beta measures how much a particular security moves around in relation to the broader market. It’s a measure of volatility in comparison to the market as a whole.

For example, a stock with a beta of 1.0 indicates that the price moves in line with the market, up and down. If the beta is more than 1.0 it implies the stock moves more than that market (in both directions). And, if the beta is less than 1.0 it means a stock moves with less volatility than the market.

REITs generally have a beta of less than 1.0. This means that whilst REIT prices won’t move up as quickly as the market does, when the market corrects, REIT prices should fall less than the market.

For comparison, utility stocks also typically exhibit a low beta.

If you think of a risk spectrum, with bonds at one end and equities at the other, REITs occupy the middle ground. While a bond gives you a certainty of getting your capital back, it lacks capital growth. REITs allow you the opportunity to enjoy capital growth and dividend growth because real estate’s value and rents tend to increase over the longer term.

So if you’re looking for relatively high, predictable, stable income, backed by real assets, then REITs should be a part of your portfolio.

Good investing,