You’d be surprised how often life gives you small clues about how to handle your finances.
A minor skiing accident a few year ago revealed that I was not very diverse in my investing.
What I am talking about probably has you scratching your heads. Let me introduce you to the situation.
A kid ran from behind me as I was getting off the ski lift at Beaver Creek in Colorado. This caused me to swerve and avoid both of us being killed. I fell and hurt my wrist. Luckily, it was not a serious injury. My livelihood as a periodontist is my wrist and hand.
I realized quickly that my sole source of income was the income from my practice.
The following questions came to my mind:
What would I have done for income if my wrist had broken?
How would I support my family in the event that I became permanently disabled?
Many people I speak with about finance are in the same situation as I was a couple of years ago. They rely on only one income stream. Not good.
Our investments at that time were mostly Vanguard index funds, which we kept in our retirement accounts. There was no passive income from investments or other sources. So, something needed to be done.
I was determined to find a way out and began by researching what wealthy investors invested in.
A statistic caught my eye.
Over 90% of millionaires own real estate.
The only real estate I knew about was the purchase of our home in 2005. My only experience with real estate was when we bought our house in 2005. That’s it.
So I decided to read books, attend conferences and listen to podcasts.
I was surprised to find out that I did not have to get a second job to become a landlord. Other options exist to enter the real estate investment market instead of becoming a full-time investor.
We wanted to have more time with our children before they went to college. Dealing with tenants wasn’t on our agenda.
We are all busy professionals, so we tend to concentrate on investments that do not take much time. Real estate syndications and REITs are two popular passive investment options.
In the past I have discussed real estate corporations. Today, I would like to focus on REITs. These are a collection real estate stocks.
Real Estate Stocks
Table of Contents
What are real estate stocks?
Buying Real Estate Stocks
Example of REIT
The Benefits of Owning Stock in a Real Estate Investment Trust
The Disadvantages to Buying Stocks in a REIT
Are Real Estate Stocks Right For You?
What are real estate stocks?
Real estate stocks include any publicly traded stock of a company that is involved in the real estate industry.
They can include:
real estate brokers
Technology companies
Manufacturers
Retailers
Developers
financiers
Here are some examples:
Zillow
Home Depot
Re/Max Holdings
CBRE Group
Toll Brothers
Buying Real Estate Stocks
Stock investing is an easy process. You can do this through an online brokerage account. You don’t need as much cash to start investing in real estate stock as you do to buy the actual property.
This is a great way to start investing in real estate if you don’t yet have a lot of money to invest.
Research and diligence are required to invest in real estate stocks, just as when buying a home. Do not invest money in an investment until you fully understand it. Stocks are defined as a small part of a company, so you should learn about the business before investing.
You can learn by reading blogs and books, or listening to podcasts.
You should be able answer a few questions to decide whether or not a stock is worthwhile to buy:
How does the business make money?
What makes this product better or different from its competitors?
How can you make more money?
What is the risk that it will fail or lose money in the future?
Is the current price of stock a good one to buy?
What about REITS?
A REIT is a real estate investment company. It owns, manages or finances real estate that generates income. Private or public REITs are available, but the latter is the most popular.
A REIT that manages and buys properties such as:
Hotels
self-storage
retail centers
healthcare facilities
Office buildings
Apartments
In order to bring the average investor in the real estate market the Congress amended the Cigar Excise Tax Extension of 1961 by establishing real estate investment trusts.
Sponsors of the bill wanted to replicate the success of mutual funds by making it easier for capital to be attracted to the real estate sector. The bill’s sponsors achieved this by using the equity structure of a mutual fund to create a real estate fund.
It allowed people with less capital to diversify and profit from the real estate markets.
Individual investors can buy shares of commercial real estate portfolios which receive income from a variety of properties.
Investors can purchase these shares through mutual funds or exchange traded funds (ETFs), individual stock of the company, or by purchasing company stocks.
It is a simple and easy way for investors of real estate to increase their portfolios.
Dividends are required by REITs in exchange for receiving a favorable tax treatment. Dividend revenue is derived from rental income and capital gain.
The majority of REITs will distribute their profits quarterly to their investors, which makes them an attractive vehicle for people who are looking for a regular income stream.
REIT Example
Here is an example of a popular REIT: the Vanguard Real Estate Index Fund.
Vanguard’s website states: This fund is invested in real estate investments trusts, which are companies that buy office buildings, hotels and other real property. This fund can offer diversification in a portfolio that already includes stocks and bonds. REITs often perform differently from stocks and bond. The fund’s dividend income may be higher than that of other funds but there is still risk.
Here is a breakdown on the Portfolio Composition.
You can see that it invests in many different types of REITs. As of this writing, the assets totaled over $64 Billion.
The top 10 largest holdings are:
Since 2001, the company has earned just over 10% of its total revenue.
The Benefits of Owning Stock in a Real Estate Investment Trust
REITs are required to pay out at least 90% as dividends. This is why most investors invest in REITs.
Dividend investors will benefit from these large payouts as they will yield above average returns.
In comparison to physical property, REITs offer more liquidity as you need only to sell your shares in order to get cash.
Diversifying your portfolio by investing in REITs is a great way to do so. Our investment portfolio consisted of 98% stocks a few years ago. I wanted to diversify a portion of my portfolio and chose the Vanguard Real Estate Index Fund. Real estate can help diversify a portfolio because it is a different asset type that acts as a counterweight for equities and bonds.
Reduced cash flow risk. REITs are a great way to reduce your cash flow risks. They offer stable cash flows and attractive returns, as they have 1000’s properties available.
The Disadvantages to Investing in REIT Stock
REITs have higher tax implications for investors who are investing for income. Dividends are taxed by the federal government at a lower rate compared to ordinary income. However, this dividend tax advantage does not apply to REITs.
Stock prices can fall when property values drop.
Tax-inefficient: Actively managed real estate, when compared to REITs, is more efficient in terms of taxation. They can depreciate their property in the first year. This can reduce their “income”.
The revenue is reduced by falling occupancy rates.
Interest rates are rising and this is affecting profitability.
Are Real Estate Stocks Right For You?
Have you set financial goals? Have you thought about how to reduce your risk in the event of injury or disability? What about risk reduction?
Diversifying your portfolio is one of the best ways to protect yourself from these negative scenarios. Real estate is a great way to diversify your portfolio. Real estate stocks allow busy professionals to enjoy the benefits of property ownership without having to be a landlord. This allows for a lower initial investment compared to spending hundreds of thousands of dollars (or millions of dollars) on a property.
If you want to know if real estate stocks will work for you, you need to determine if you have the temperament and ability to deal with the ups and downs of stocks. You also need to be able to identify long-term investments that are worth your time.
This article was originally published on Your Money Geek. It has been republished by permission.
