Pros and Cons of REIT Investments-How to Build Real Estate Wealth
REIT Pros & Cons
Learn how to invest in real estate funds without much cash. Discover whether adding real estate to your investments is right for you in this 2nd part of the Real Estate Investing Series.
Part 1 of this Real Estate Investing Series-“Being a Landlord Sucks-Why You Shouldn’t Invest in Real Estate” – detailed 26 Steps to Buying and Managing Rental Real Estate.
Part 2, “Pros and Cons of REIT Investments – How to Build Real Estate Wealth” – is for those of you who want exposure to real estate investing but don’t have tens of thousands of investment capital to invest. Or, you may have the capital but not the time or energy to devote to this “not passive” investment opportunity.
A Brief Lesson in Diversification – Investing in Real Estate Matters
Long before Modern Portfolio Theory proved the benefit of diversification, “Don’t put all your eggs in one basket” was practiced. Intuitively, it makes sense to spread your income and investing risk around. The rationale behind diversification and asset allocation is that when one asset goes down in value, another may go up. Spread your investments and risk around and you’ll decrease the volatility of your returns.
For example, invest only in one stock market mutual fund and when the stock market falls 20% in a bad year, so do your investment returns. Add a bond mutual fund to the stock fund and even if the returns on the stock fund fall, the bond fund’s returns might go up 15% and make your total portfolio value more stable.
Add real estate to the mix and the added diversification, and lower correlation with the other asset classes increases returns and lowers overall risk of your portfolio.
By adding various asset classes to your investment portfolio your portfolio risk declines and return improves.
What is a Real Estate Investment Trust (REIT)?
So, you want to add real estate to your investments but don’t understand the whole real estate investment company idea.
According to REIT.com, a REIT is a company, similar to a mutual fund that owns or finances income-producing real estate. There are many types of REITS from office, industrial, lodging, self-storage, infrastructure, mortgages, diversified and more. Due to the vast choices in real estate investing, you can choose to invest in a specific type of REIT or go with a broad REIT index fund that provides exposure to a variety of types of real estate.
” REITs earn a share of the income produced through real estate investment – without actually having to go out and buy or finance property.” ~REIT.com
I’ve invested in both bricks and mortar real estate and REITs and I’m a fan of REITs. You’re not going to get a tenant calling at 2 am with a broken pipe. When investing in a Vanguard REIT fund you won’t worry when a tenant moves out before the lease is up.
Investing in a real estate fund is as easy as reviewing a list of available funds and clicking “buy” at your online discount brokerage account. But before you rush out to invest, check out the pros and cons of REIT investing.
Pros of REIT Investing
- You get a steady income stream because REITs are required by law to pay out most of their income in dividends.
- REITs have a long track record of growing their dividends.
- The properties owned by the REIT companies have appreciated in value over time, thus growing your initial investment.
- REITs are professionally managed, to get the greatest returns on the individual properties.
- Over the past 20 years REITs returns have trounced that of the S&P 500 and other major indexes as well as inflation.
- REITs are easy to buy and sell through your online investment account. My spouse even invests in a REIT fund in his 401(k).
In our own family’s investment portfolio, REITs have been outstanding performers in recent years. But, it’s crucial to understand that every investment has its risks.
Cons of REIT Investing
- As interest rates rise, financing real estate will become more expensive and borrowers will pay higher interest costs. This can put a damper on future REIT investment returns.
- REIT fund values go up and down. Imagine that you buy Vanguard REIT ETF (VNQ) today, March 31, 2017, for $82.00 per share with a current 4.66% yield. If the price falls, your investment will be worth less. You’ll still receive your dividend payment, but the total value of your investment will decline.
- Although you typically earn a juicy dividend on your real estate investment, you’ll have to pay taxes on those dividends, typically at a higher rate than the 15% levied on most dividends. The reason, according to Morningstar.com, is because most REIT income is considered ordinary income, although this varies by REIT.
If you’re still considering a dive into the real estate investment markets, here are some REIT ideas.
REIT Index Mutual Funds and Exchange Traded Funds (ETF)
Here’s a list of several national and international REIT funds for your information.
- VGSIX-Vanguard U.S. REIT Index Mutual Fund
- VNQ-Vanguard U.S. REIT Index ETF
- RWR-SPDR Dow Jones Index REIT ETF
- VNQI-Vanguard Global ex-U.S. Global Real Estate ETF
- FGL-iShares Developed Real Estate (ex-U.S.) ETF International Fund.
- RWX- SPDR Dow Jones International Real Estate exchange-traded fund.
The REIT Investing Takeaway
You diversify your investments because you don’t know which financial assets are going to shine and which ones will lag. Even if REITs aren’t the #1 performers in the next year or two, over the long haul, they’ve proven to be a solid way to invest in real estate and grow your financial net worth.
Don’t miss part 1 of this Real Estate Investing Series-“Being a Landlord Sucks-Why You Shouldn’t Invest in Real Estate” – with 26 Steps to Buying and Managing Rental Real Estate.
Caveat; The mutual funds and ETFs are offered for informational purposes only.
Although REIT investments have performed exceptionally well over the past 10 years, there is no guarantee that their outperformance will continue in the future. This article is not a recommendation to buy or sell any specific securities.
disclosure; I own shares in RWX and VNQ
A version of the article was previously published.
Do you diversify your investments? Where does real estate fit in with your plan?