What is a REIT?

I am currently watching Love is Blind Season 5 (this show is past its peak..), and I am starting a formal petition to add a “Financial Counseling Session” to the pre-marriage episodes. I don’t even want to host it! These people just need to have the money talk.

I have mentioned REITs in some recent newsletters and am excited to deep dive them. REITs (Real Estate Investment Trusts) are companies that own, operate, or finance income-producing real estate. It is a neat way to diversify with real estate while retaining the flexibility and ease of owning stocks.

To qualify as a REIT, the company must:

• Hold 75% of assets in real estate, cash, or US Treasuries

• Earn 75% of gross income from real estate related investments (rents, mortgages, sales)

• Pay at least 90% of taxable income in dividends to shareholders

There are a few other requirements, but those three are the important ones. REITs are more about the dividend payments over the value appreciation. The price of the individual stock will probably remain constant or decrease, but your reinvested dividends will grow overtime.

You might be saying, “Wilson, two weeks ago you argued that dividends are stupid! Now you are saying they are better?” Fair question. REITs are not like other companies. When I argued for growth over dividend investing, I was comparing companies like Pepsi (3.16% dividend) and Tesla (no dividend). REITs are a separate asset class altogether, and therefore should not be compared to other companies.

There are three types of REITs:

• Equity - Equity REITs buy and hold income-producing real estate and derive most income from rents.

• Mortgage - Mortgage REITs lend money to other people to buy real estate. Most of their income comes from the interest on these loans.

• Hybrid - Hybrid REITs hold a hybrid of equity and mortgage investments.

Within the equity category, there are even more classifications: Commercial, Residential, and Healthcare. These are REITs that focus exclusively on a specific sector of the real estate market. If you buy REITs only in one of those categories, you are increasing your risk.

How do you know which category a REIT falls into? There is a good chance the name gives it away: Blackstone Mortgage Trust Inc. or Medical Properties Trust Inc. The commercial/residential names are less obvious. Simon Property Group or Realty Income Corp don’t give away what they hold. That is when Google is your friend. However, like everything, we recommend avoiding picking individual REITs and stick to the REIT ETFs if you want to dip your toes into this asset class.

Let’s start with some cons of REITs:

• Taxes - The dividends from REITs are not qualified dividends. Which means your dividend payments are taxed as regular income.

• Risk - The real estate market is an odd beast. While most of the stock market has been rallying this year, REITs have been far underperforming due to rising interest rates. There are more/different factors that affect the REIT world.

• Higher Management Fees - Since REITs consist of large real estate portfolios, they typically have higher management fees which eat into dividend payments. Since these are companies, the management fees are not easily accessible like expense ratios of ETFs.

Now let’s look at the pros:

• High Dividend Yield - Some REITs achieve much higher yields which offsets the lack of appreciation. High-performing REITs have dividends around 8%, and REIT ETFs range from 3-12% yield.

• Diversity - REIT ETFs are great ways to diversify your portfolio. Not only with different companies, but with an asset class that will be affected by different factors. Yes, I just said this does increase risk. However, there is a benefit to owning assets that react differently to market conditions.

• Owning Real Estate - Do you actually own real estate when you own a REIT? Technically, no. But, you own shares of a company that, unlike other companies, is legally required to hold a percentage of assets in real estate and distribute 90% of taxable income. You have the liquidity of stocks, no responsibility, and much lower risk so your reward is smaller. You get some of the good from owning real estate with none of the baggage.

• Fixed Income Planning - REITs fluctuate more than bonds, but they offer higher returns. If you are looking to build a fixed income portfolio, REITs may be a large portion thanks to relatively consistent quarterly or monthly payments.

I own REITs thanks to Jeeves, my Robo-Advisor. He bought me three ETFs: SCHH (US REIT), USRT (US REIT), and HAUZ (International REIT). They have provided consistent, quarterly dividend payments. I still reinvest all my dividends, but I appreciate tracking its growth and record.

Call to Action

Before buying any REITs, compare the ten year performance with other REITs and ETFs. This is a very different beast than just buying an S&P 500 ETF or a total market ETF. As always, past performance doesn’t guarantee future results.

What We’re Reading/Listening To

Investopedia.com. This website is an awesome resource for all things finance and helped me when writing this letter. If there is a question that we haven’t answered, send it to us so we can! If you can’t wait, check out Investopedia.

Debrief on Deck

Next week, Mike is going to talk about Social Security. Was he supposed to talk about it this week? Yes. Did we call an audible? Also yes.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

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