Owning an investment property is not as simple as buying a property, renting it out, and then collecting a monthly check. Landlords must manage the taxes, make necessary repairs, and find suitable tenants. While you can always hire a property management firm, the cost will eat into your profit margin. Real estate can be an attractive investment if done correctly, yet being a landlord can be a daunting task. Owning just one rental property can also be risky. If you don’t have the capital to invest in many property types across various geographic regions, one rental property will likely end up being a high proportion of your overall investment portfolio. Any issues with that one property can lead to a large dent in your assets. The good news is you can still invest in real estate without the hassle of being a landlord with Real Estate Investment Trusts (REITs). Publicly traded REITs are as easy to own as a publicly traded stock, give investors exposure to a wide range of property types, and add something unique to your portfolio that increases diversification.
First, what exactly are REITs?
REITs are investment vehicles that own and manage real estate properties. These companies collect the rental income from the properties and pass at least 90% of taxable income on to its investors. The properties include everything from apartments, offices, hospitals, and malls, to less traditional real estate like self-storage centers, cell phone towers, website-hosting facilities, and highway billboards. Public REITs trade just like stocks on an exchange and are therefore cheap and easy to buy and sell, unlike physical rental properties. The best way to get access to a diversified mix of property types is by investing in a fund that owns many different REITs. For example, a fund that tracks the FTSE NAREIT All Equity REITs Index, one of the more well-known US REIT indexes available, would give you access to the mix of real estate sectors shown below.
Investing in a diversified REIT index similar to the illustration above should involve less risk than buying a rental property. You’re not putting all of your bricks into one building!
Adding a REIT fund to an existing portfolio of stocks can also improve the diversification of that portfolio in several ways. While stock returns are ultimately tied to company earnings, REIT returns are tied to the income and value of real estate properties. This unique source of return means that REITs behave differently than stocks, which also means they can help reduce risk when added to a stock portfolio. During down periods for stocks, REITs have historically experienced less of the downside. The table below shows periods over the last 25 years when the S&P 500 experienced a negative total return of 10% or worse, as well as the total return for the FTSE NAREIT All Equity REITs Index during those periods.
US real estate generally held up better during those periods, with the one negative outlier coming during the financial crisis that followed a period of inflated real estate prices. The period following the burst of the Dot-Com Bubble in 2000 was another outlier, though that same year real estate investors were greatly rewarded. This time US real estate outperformed the S&P 500 by over 67% from September 1, 2000 to October 4, 2002.
If you are interested in investing in real estate, and there should be plenty of good reasons to do so, you may want to consider REITs before taking on the responsibility of becoming a landlord. Owning REITs instead of a physical property should save you time and stress, involve less risk, and will still add a diversifying asset to your portfolio.
Important disclosure information
The index returns shown above reflect the total return for various investment indices and include the impact of the reinvestment of dividends. A comparison to indices may not be a meaningful comparison. Comparisons to benchmarks have limitations because benchmarks have volatility and other material characteristics that may differ from the performance of a client’s portfolio. The investments in a client’s portfolio may differ substantially from the securities that comprise each index and are not intended to track the returns of any index. One cannot invest directly in an index, nor is any index representative of any client’s portfolio. Actual client accounts will hold different securities than the ones included in each index. The index returns are gross of applicable account transaction, custodial, and investment management fees. The actual investment results would be reduced by such fees and any other expenses incurred as an investor. For definitions of the indexes used are below.
Index: FTSE NAREIT All Equity REITs Index
All tax qualified REITs with common shares traded on the New York Stock Exchange, American Stock Exchange or NASDAQ National Market list will be eligible. In order to operate as a REIT, publicly traded company must receives at least 75% of its annual gross income from real estate rents, mortgage interest or other qualifying income; have at least 75% of the company’s annual assets consisting of rental real estate, real estate mortgages or other qualifying commercial real estate; and the company must distribute annually at least 90% of its taxable income to its shareholders. Minimum Size: Only companies valued at more than USD 100m at the date of the annual review will be eligible for inclusion in the index. Minimum Liquidity: Securities which do not turnover at least 0.05% of their shares in issue per month in at least ten of the twelve months prior to the annual review in December, after the application of any free float adjustments, will not be eligible for inclusion in the index.
Index: S&P 500 Index
The S&P 500 is an index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Each constituent in an index is weighted by its market-capitalization, as determined by multiplying its price by the number of shares outstanding after float adjustment. The price return of an index is a measure of the cap-weighted price movement of each constituent within the index.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
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This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.