For many investors, the lure of real estate is, well… real. You’ve heard “get-rich-quick” success stories; you’ve done a bit of research; you’ve heard from your friend, the real estate agent, that its the best investment around. We’ll tell you right off the bat: to an agent, real estate is always a good investment.
Does that mean that it’s the best investment for your portfolio? Real estate at its best can have the potential for great returns, and, for the most part, can provide you with ample diversification benefits. But before you go buying that rental property, let’s get it straight — the best of real estate investment won’t come in owning your own home or renting out those apartments.
Let’s dive in.
Two ways to invest in real estate
For a bit of a primer, there are two top-level ways to invest in real estate: direct ownership and buying shares in a real estate investment trust.
Direct ownership is exactly what it sounds like: purchasing properties with the intention of flipping them, or renting them out over time. While the current market of low interest rates and high rental demand can make this seem attractive, don’t be fooled into thinking it’s a passive investment. Being a handyman and a landlord is a job, and not necessarily one that comes with returns as you battle tenants who don’t pay and repairs that creep up. In addition, it’s never safe to assume that today’s rising demands and rental rates mean guaranteed future cash flow, as the market ebbs and flows.
For the purpose of this article and diving into the best potential for real estate investments, we’re not just talking about making the move from renting to taking on that mortgage in favor of owning your own home; nor are we talking about buying that apartment building to rent out. We’re talking about the second option for real estate investment: buying shares in real estate investment trusts (REITs) with the intention of investing in diversified real estate portfolios with long-term returns.
Real estate investment trusts (REITs)
Investing in REITs means buying shares of a portfolio of properties managed by the company that owns or finances income-producing real estate (the REIT, itself).
REITs are required by law to invest at least 75 percent of total assets in real estate, and derive at least 75 percent of gross income from rents from property, interest on mortgages financing property, or sales of real estate.
What’s more is that REITs are required to pay at least 90 percent of taxable income in the form of shareholder dividends each year. That’s where those who invest in REITs see their return: much like buying stocks, REITs allow investors to buy into portfolios of large-scale properties through the purchase of stocks, then pay out in the form of dividends.
These portfolios can be built on properties of all sorts: from apartments to hospitals, hotels to industrial facilities; nursing homes to shopping malls, and much, much more.
The benefits of investing in REITs
To be clear, REITs are predominantly traded on major stock exchanges, but public, non-listed REITs as well as private REITs do exist. To put yourself in position to reap the most potential benefits, publicly-traded REITs are top. These REITs have a few hard and fast benefits that cannot be ignored:
- Liquidity. As stock exchange-listed investments, REITs can easily be bought and sold, making them, at most times, very liquid.
- Diversification. In the long term, publicly-traded REITs have found to have only low-to-moderate correlation with the stock market, giving you a diversified asset in your portfolio.
- Dividends. Like other publicly-traded stocks, REITs pay out investors in the form of dividends, offering a stable income stream over time.
- Transparency. Because of their public nature, stock exchange-listed REITs operate under the same rules as other public companies in the eyes of regulators.
Of course, while REITs shine when it comes to all of the above, it’s important to pay attention to where they can be deceiving.
Because of the structure of REITs, their performance tends not to always correlate with actual property values, instead more closely aligning with stock market performance. For this reason, it’s wise to put a cap on real estate exposure in a portfolio.
Making the decision on real estate investments for your portfolio
Like any good investment, it’s important to focus on diversification. When investors think of putting money into real estate, their first thought is often direct ownership — but not only is it not the only way to invest in real estate; it’s oftentimes not the smartest way to invest in real estate.
Good REITs are liquid, publicly traded, and professionally managed — giving you diversification and stability. At WorthPointe, we strategically use REITs to build global real estate portfolios. That being said, your portfolio cannot alone be built on real estate, no matter how diversified your ownership or the fund. Working with a Certified Financial PlannerTM who knows your assets and your goals is key to building the portfolio that will help you meet them.
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