Investing in Real Estate Investment Trusts (REITs) can provide dividend investors with high yields, steadily growing payouts, nice diversification, and an attractive income stream for retirement living.
However, REITs have a number of complexities and risks that should be understood before making any investments.
Before jumping into the essential information investors need to know about REITs to make better informed decisions, it’s worth highlighting some of the sector’s appeal.
For one thing, $100 invested across all REITs in 1971 would have grown to nearly $6,000 in 2015, representing compound annual growth of about 10%:
Source: Simply Safe Dividends, REIT.com
When it comes to building wealth few industries are more time tested, or successful, than real estate. In fact, real estate is the third biggest creators of the world’s billionaires:
This is understandable given that real estate has a several built-in advantages that naturally make it appreciate in value. For example, the growing global population generally leads to both economic growth and higher demand for land and properties involved in housing and industrial development.
In addition, the ability to use leverage (i.e. buying real estate properties with debt, such as a mortgage) means that investors can generate substantial returns on investment.
Furthermore, real estate is usually a cash rich business thanks to rent income, which makes this kind of investment highly attractive to long-term investors. And finally we can’t forget the numerous tax benefits of real estate, including the ability to deduct depreciation expenses from earnings, and mortgage interest from taxable income.
But for most retail investors, the idea of investing in real estate other than their own homes can be intimidating. After all, owning a rental property can be extremely hands on and time intensive. In addition, there are numerous legal implications, as well as risks that becoming a landlord involves, that most people simply don’t have the time or desire to get involved with.
Fortunately, there is a much simpler way for long-term income investors to profit from real estate, one that is no more difficult than buying shares on a stock exchange.
What are Real Estate Investment Trusts?
Real Estate Investment Trusts, or REITs, were created in 1960 as a new, tax efficient means of helping America fund the growth of its rapidly increasing demand for all types of real estate.
Basically, REITs are pass-through equities in which the company pays no federal income tax as long as it pays out at least 90% of its taxable income as unqualified dividends to investors.
The result is a naturally high-yielding class of equities in which the business model is predicated on constantly raising new external growth capital from the debt and equity markets in order for management to grow its portfolio of cash producing properties; thus allowing dividend growth over time.
And since market studies show that a good rule of thumb for long-term total returns, which include dividend reinvestment, is yield + dividend growth, rising dividends generally result in share price appreciation.