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2020 Cheat Sheet for Understanding REITs

Capitalism.com
|
February 7, 2020
real estate investing to plan for the future

87 million Americans can’t be wrong. Investing in a REIT is one of the best ways to plan for the future.  

Some of the wealthiest people in the world invest in real estate. While you may picture flipping homes or managing rental properties as the only way to make money in this industry, there is something even bigger out there, with the potential of earning you millions or more.

Contrary to popular belief, buying a home is not a real estate investment—unless you’re the bank financing the mortgage. Instead, a house is a tangible good that does not produce a stream of income. While homeownership should be a goal, it won’t pay the bills.

However, a REIT (real estate investment trust) is a liquid investment and perhaps the best way to make real estate work for you. Today, nearly 87 million Americans invest in REITs—whether they realize it or not—through retirement plans, mutual funds, or a REITs EFT. Adding a few real estate trusts to your portfolio may reduce your investment risk and increase returns. 

What Does a REIT Do?

Real estate is a necessary commodity, but it’s also a pricey one. Corporations often form REITs as a way to back and fund their real estate ventures. Similar to stocks, you can buy shares of a publicly-traded REIT on the New York Stock Exchange. The NYSE has a comprehensive list of REITs available, along with their current share prices.

 But how are REITs different than standard stocks? From an onlooker’s point of view, these two investments are very similar. However, when you purchase a REIT share, you are not buying into a particular company. Rather, you are investing in the actual real estate property itself.

REIT investments can cover a wide range of properties, such as apartments, office buildings, and retail centers. While some real estate trusts focus on one subset, others may include a variety of properties types in their portfolios. 

what does a real estate investment trust do

There are 12 listed REIT sectors, including:

  1.   Office
  2.   Industrial
  3.   Retail
  4.   Lodging
  5.   Residential
  6.   Timberland
  7.   Health care
  8.   Self-storage
  9.   Infrastructure
  10. Data Center
  11. Diversified
  12. Specialty

Investors appreciate REITs because they help diversify and build a strong portfolio. Unlike other stocks, the success of a real estate trust doesn’t correlate directly with other assets. Because of this, many investors believe real estate is a sound way to reduce overall portfolio risk and increase returns. 

Are REITs Good Investments?

Real estate is a hot commodity. People need places to live, and companies need buildings to house them. For this reason, REITs will always be in demand. Although the value of a REIT may go up and down with the waves of the market, most experts feel these investments are a reliable way to diversify a robust portfolio.

If we analyze the historical performance of REITs, you’ll understand why investing in them may be a lucrative option for you. Here’s what a REIT can offer investors: 

Long-Term Performance

Buying into a REIT is not some “get rich” scheme. It takes time and a ton of patience to enjoy the benefits. History demonstrates most real estate trusts perform the best over a long period and provide returns similar to other well-performing stocks.

Stable Dividend Yields

A REIT’s dividend yield can often outperform even in unstable markets. You may be able to enjoy a steady stream of income even when the market is not at its peak.

Diversification

The most successful investors have complex, diverse portfolios—they don’t keep all their eggs in one basket. Adding REITs to your portfolio is one way to capitalize on your investment during all phases of the market. In many instances, when the broad stock market goes down, these real estate shares hold their own or go up. Their performance is not related to the market as a whole. 

Don’t Take Our Word for It—Ask a REIT Expert

Real estate investing is one of John A. Kilpatrick’s favorite pastimes, and it also provides him with a well-funded life. He first developed a keen interest in the topic as a young child—his dad has some friends in the real estate investing business. John began absorbing everything these friends would say; however, little did his young self realize how much these conversations would pave a golden path to his success.

And, no, John didn’t just rely on a few conversations he heard as a child. He has also thoroughly studied the real estate market and has a Ph.D. in finance. During his graduate studies, John’s dissertation professor suggested he research REITs. Although he wasn’t really interested at the time, John decided to follow his professor’s guidance.

Eventually, John began working on Wall Street. His initiation into REITs started when a client hired him as the CFO of a real estate development company. Now, almost 40 years later, John runs two private family funds—one exclusively invests in REITs.

John knows the pros and cons of REIT investing, but in his experiences, the plusses have outshone the negatives time and time again. You need to understand the market and subsections to achieve success. If you look at REITs in the same manner as traditional hedge funds, it’s easy to pick and choose winners. He recommends going long on the best-performing companies and going short on the worst one. With this mindset, John has seen great success with his investments.

When John first began, there was nothing quite like real estate trusts anywhere else in the world. Today, there are a few small REITs in the UK, but nothing as powerful as the more established sectors in the United States. In March 2019, the first REITs in India went up for trade. Even though this type of investing has become a worldwide phenomenon, the most lucrative trusts still remain right here at home. 

John’s Advice for the Novice Investor

Anyone can diversify their portfolio with REITs, but before you do, it’s crucial to understand how to begin. John describes real estate as a “unique instrument.” Real estate makes up a considerable chunk of the economy and encompasses a variety of sectors. 

When you first start dabbing into REITs, John recommends beginners stick with publicly traded shares. You’ll find these on the New York Stock Exchange. As your REIT knowledge increases, you may look into private REITS, which are an entirely different beast—and they can inflict a serious bite!

But, when private a REIT outperforms, taming the beast is worth the effort. Some of the wealthiest people in the world have family-formed REITs, many of whom are on the Forbes 400 list. And there is one surname you’ll see pop up time and time again—Walton. 

What Do Jim, Alice, and Rob Have in Common?

Walmart is a prime example of the American dream. Sam Walton built his Walmart empire on the premise that he could offer better prices than stores in neighboring cities so customers would not have to travel far for a great deal. This brilliant—yet surprisingly simple—idea remains the goal of Walmart stores across the country.

Although the founders of Walmart—Sam and his brother, James—have long since passed away, their family still enjoys the fruits of their labor. Today, the Walmart family continues to rank as the wealthiest family in America. Heirs, Jim, Alice, and Rob Walton, have a seemingly permanent spot on the Forbes 400. 

Jim, Alice and Rob Walton - heirs to Walmart

Imagine Growing $4 Million Richer Every Single Hour, 365 Days a Year

This type of unfathomable wealth is the daily reality for the Walton family. The amount of money flooding their bank accounts each second is enough to make your head spin and smoke shoot out your ears. Most people can’t even comprehend that amount of money, yet one family continues to rake in the dough daily. As Bernie Sanders once tweeted, “The Walton family makes more money in one minute than Walmart workers do in an entire year.” 

While Bernie’s statement may seem like complete bologna at face value, let’s delve into it a bit more. The Washington Post reported the Walton family earns $3,138,649,017.92 in dividends alone each year. If Jim, Alice, and Rob all worked a standard 40-hour workweek, they would each make $25,149 per minute. Not too shabby for 60 seconds at the office. 

What’s The Secret to Their Billions? REITs!

While you may assume all the money in the Walton family comes from Walmart’s success and booming stocks, there is much more to the story. Sure, Walmart stock isn’t hurting their wallets, but it’s not the only thing padding their bank accounts. Family REITs are perhaps the main reason for the continued and mind-blowing success of the entire Walton family.

Not only do Walmart stores bring in a substantial income, but the real estate they occupy is also profitable. Unlike other businesses, the family owns these properties outright, and they hold them in the Walton Family Trust as REITs. So, even when Walmart operations stir up a bit of controversy, the family’s REITs still turn a profit. Sam Walton knew a bit more about economics than just rolling back prices. 

How Do You Make Money on a REIT?

Now, all this may sound great to you (who wouldn’t want to make millions a minute?), but is it a sound investment? Unlike other investments, most REITs provide both high dividends and long-term capital appreciation. There are not many reasons why not to invest in REITs.

One way to make money from your investment is through buying and selling. You can buy a REIT share for low and sell it when the value increases. Treating REITs like traditional stocks have proven lucrative to many investors. However, this is not the only way you can turn a profit. 

The most successful REIT investors make money through dividend payouts. Since the government offers tax benefits to real estate companies, they also place strict guidelines on how REITs must operate. 

For example, a legitimate real estate trust must derive most of its profits from rents, as compared to development or trading. Furthermore, the corporation must pay at least 90 percent of the REITs taxable income to shareholders. The longer you hold a REIT—even if the market declines—the bigger your potential for significant dividend returns. 

average return on real estate investments

Are REITs Riskier Than Stocks?

There’s a reason why so many tourists travel to Las Vegas every year—people want to hit the jackpot. However, as with any game of chance, the odds must be in your favor win a game of blackjack.

Many novice investors view the stock market in the same light as Vegas or the lottery. And while not every stock is a winner, you can make a sizable fortune if you play your cards wisely. The same theory is true when it comes to REITs. If you buy into the right fund, you may win big. Of course, if the market isn’t in your favor, the dealer (also known as your broker) may call you with some bad news.

But is buying into REITs a riskier venture? Once again, this is a very open-ended question and not something a blog can quickly answer for you. How you manage your funds will be the determining factor in how the value of your investment grows or shrinks with time.

There is good news, however. REITs have a proven track record for performing well in the long run. Now, if you only want to invest for a year or two, you may want to run away from buying a REIT as the return may be abysmal. But, as long as time is on your side, you can achieve impressive capital appreciation. Investors enjoyed a better ROI with REITs over the past 45 years than those who bet it all on stocks and bonds. 

Can You Reduce Your Risk?

Even though you can never eliminate the risk of any investment, you may be able to boost your odds of success if you have a proven strategy. Once upon a time, financial experts—and the Wall Street Journal—discouraged geographical diversification of REITs. There was an assumption that buying real estate shares across the USA was a bad idea, and as John A. Kilpatrick learned, this advice couldn’t be further from the truth.

In Arrested Development, George Bluth, Sr. reminded his zany family on countless occasions, “There’s always money in the banana stand.” And wise investors know you can always make money in real estate. No matter if the market goes up or down, those who ride out the rollercoaster and put their savings in REITs usually come out ahead. But, if you really want to lay a big, fat nest egg, you need to diversify.

Heaven forbid something were to happen to your banana stand, and it was to (spoiler alert) burn down. All the money you had in the stand will also go up in smoke, and you’ll have nothing to show for all your hard work. But investors with a keen understanding of REITs know the importance of buying into a variety of funds. The more you diversify, the safer your investment. 

What Is the Average Return on a REIT?

Buying into REITs and letting it grow for many years may turn out to be the best investment you ever make. The average return on these real-estate backed funds often outperforms the highly acclaimed S&P 500.

For the past two decades, the S&P 500 averaged an annual return of around 8.6%, yet typical REITs outperformed this number with a 9.5% return rate. Of course, some real estate investments perform better than others, and most investors find residential portfolios do better than other types of REITs.

This past year, many investors were more than happy with their returns. The best REITs in 2019 produced historical yields. In this bullish market, these portfolios topped a staggering 14%, which was more than the 12% the S&P 500 enjoyed. Financial forecasters believe REITs will continue to outperform the broad stock market for at least the next few years. 

Can REITs Lose Money?

After hearing all this talk of REITs outperforming other stocks may leave you hungry to build your portfolio. Before you call REIT Vanguard or your private broker, however, you need to be aware of one simple fact—a real estate trust can lose money.

But didn’t you just read these investments are better than the well-trusted S&P 500? Don’t they always bring in a steady income? No, they don’t. Just as with the broad stock market, the value of your REITs portfolio will go up and down as the real estate market waxes and wanes. When the market is good, your returns will increase, but if the bubble bursts, you may find yourself empty-handed. 

REITs are not a safe buy for the short-term investor. After the 2008 financial crisis, real estate prices crashed. If you invested all of your savings into real estate, your heart probably skipped a few beats or flatlined for a second. However, the market eventually bounced back, and those who chose to wait it out found themselves earning larger yields than ever before. And those who continued investing through 2019 made massive gains. Time is your best friend when it comes to accruing wealth through REITs

TLDR: Be Smart

There’s money in real estate if you know how to make wise investments. REITs provide a way to buy into real estate without worrying as much about the volatility of the stock market. As long as you don’t mind waiting to see massive returns, the dividend payouts and yields of real estate trusts often outperform broad market stocks. It’s time to consider adding a variety of REITs to your growing portfolio.

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