Everybody wants a piece of land but not everyone can afford it. This is where REIT’s come into picture. REIT’s are securities that invest in real estate and pay dividend. Most of the REIT’s make money by renting the land they own to individuals or businesses. However, some also make money by funding real estate venture and by earning interest on the mortgage bonds they fund.
Well diversified REIT’s portfolio on an average have a dividend yield of 6%. By law REIT’s are required to return 90% of the income as dividend if they want to preserve their exclusive tax advantage. As a result the dividends keep coming irrespective of share prices going up or down.
However, REIT’s dividends are not taxable at ordinary dividend tax rate of 15% instead they are taxed at ordinary income tax rate of 35%. Even after this the average yields REIT’s return is greater then average stock yields. Furthermore, these taxes too can be avoided by holding REIT’s in Roth IRA.
Tangible in Intangible
Demand-supply equation in real estate is always negative on the supply side as quality real estate is always scarce. This makes the REIT’s sought after amongst income investors.
REIT’s give real estate savvy investor economical and risk reduced way to invest in real estate. In a world without REIT’s investor himself would have to buy land, stand loan guarantee and be liable for damage to the property.
Investors very often get burned when they just look at the dividend yield while buying stock. Company’s ability to pay dividend today is by no means a guarantee that it will be able to continue to do so in the future. The sample of companies that have been able to do the same is not very large.
Same rules apply to REIT’s. Profitable stocks that generate the biggest combination of dividend and share price appreciation i.e. total return. It would be a very unwise move to look at yield rather then total return for long term investors.
REIT might have exceptional track record of dividends and share appreciation, but the most significant factor to be looked while investing is the property REIT has under its management.
REIT’s are different from each other with respect to the kind of property they have under them like businesses, hotels, malls, health cares etc. There are some REIT’s that are diversified like Duke Realty (NYSE:DRE) which has combination of retail, industrial and office property. While others like Entertainment properties (NYSE:EPR) just have movie theatres under them. Some of our favorite REITs are mortgage REITs…which invest in just mortgages.
Sine wave for each REIT’s is different as each real estate sector has different business cycle. Property types are a strong indicator of the volatility in the REIT’s income. Like apartment houses have short term leases and as such have higher volatility whereas malls generally have long term lease of about ten years implying more steady income.
REIT’s income is further depended on how well geographically diversified they are. REIT’s that have property spanning across the length and breadth of the country have a stable source of income as the impact to the income due to a particulars economic activity is absorbed by the cash flow from other regions. However, there are high growth REIT’s that are basically present only in a particular area and guarantee high return when this regions economy booms.
REIT’s investor should always look at funds from operations (FFO). As REIT’s own land they have a large non cash depreciation charges which affect the net income. FFO are a better indicator of the funds available for distribution as dividends.
Overall if investors are looking at long term horizon, REIT’s offer lower risk and higher return in contradiction to the world of finance.