Are you a 9 to 5 working class, earning pay check to pay check?

Feeling tired to a slave of money?

Do you want a change?

What if you can have money going to work for you earning you cash, tirelessly, every single day, 24/7 without a break.

How great will it be, don’t you think?

Introducing Real Estate Investment Trust (REITs), a very different class of investment vehicle you may want to consider.

What are REITs?

REITs is an investment on real estate or equivalent that generates you cash at the end of every period in the form of dividend. Some REITs pay out every month, and others every quarter or bi-annually.

How are REITs different to stocks?

REIT investors own shares in a trust that owns and manages a collection of real estate properties, while stock investors purchase shares in the ownership of a public company or business.

Unlike stocks, REITs is only investment that by law have to distribute 90% of its taxable income after expenses to their shareholders annually in the form of dividends.

This give an average of annual dividend yield of approx. 5%. (Not including the capital gain you are getting for buying the REITs).

Like all investment, REITs have their own benefits and risks.

By balancing the pros and cons of a REIT, you can choose which is the best investment vehicle that suits you.

Sun Tzu once said:

“If you know the enemy and know yourself, you need not fear the result of a hundred battles.

If you know yourself but not the enemy, for every victory gained you will also suffer a defeat.

If you know neither the enemy nor yourself, you will succumb in every battle.”

What are the risks of REITs?

REIT like every form of investing have their own risk. REITs is the investment on real estates, thus REITs faces the same risk as all real estates.

Of many risk it may face, the following are some of the few you may want to consider.

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Unpredictable

Designed and traded similar to conventional stocks, REITs can be unpredictable and can have price fluctuation from time to time.

You can buy ‘ABC REIT’ today at $1.00 and it can become $0.80 tomorrow.

20% drop in value for a REITs at a short time may not be common, but it is possible. Like all stocks, REITs can gain 20% in value at a short period of time as well.

Before you buy any REITs, you should understand that unpredictability is the nature of most investment vehicles.

Nonetheless, REITs generally fluctuate much less in compare to penny stocks or stocks in general. These other investment vehicles can drop 90% of its value in 1 hour and raises 20% in the next minute.

Thus in comparison, REITs generally fluctuates less than general equity market.

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Risk of REITs - Unpredictable

Sensitive to interest rate

John Laforge, head of real estate asset strategy at Wells Fargo Investment Institute, once said:

“I wouldn’t look at REITs as having any more risk than a traditional stock, but since they do have a higher dividend yield, they can be more sensitive to interest rate movements.”

What does he mean?

Let’s illustrate it with an example:

Generally speaking, an average REITs give around 5.20% dividend yield as shown by current data from dividend.com.

Note: 5.20% dividend return is when not including the capital gain from investing in REITs.

When long-term yields government bonds such as, those on 10-year and 30-year U.S. Treasury rises. These government bonds which generally are considered ‘risk-free’ investment become a competitor for REITs.

Note: No investment are ‘risk-free’, but generally speaking, government bonds are considered ‘risk-free’ by many as unless the government collapse, your principle will be return to you at the maturity of the bond.

Long-term yields government bonds generally gives a low yield of on average 4.55% per year, as reported by ycharts.

Historically, long-term yields government bonds can be as low as 1.36% per year in July 2016 and as high as 15.82% per year in September 1981. As reported by TradingEconomics.

These long-term yields government bonds when have their interest rate raise to a high of over 10% compete become a strong competitor against REITs for investors’ money.

This is called the “crowding out effect” in investing.

For instance, today the ‘risk-free’ 10-year Treasury bond rose from 2.5% to 4.0% in the first two months of this year, in contrast the REIT market fell 5%.

With just a 5.20% yield on a REIT, it will look less appealing. With just a 1.20% more on dividend yield, you are exposed to the risk of the market fluctuations.

Since you can get a 4.0% ‘risk-free’ return on a 10-year Treasury bond, many investors will prefer invest their hard earn money on bonds instead.

This will lead to the further price drop of REITs, and thus your investment return will be impacted.

Sector Dependent

In my other article, we talked about the different common Types of REITs, such as; Commercial, Healthcare, Hospitality, Industrial, Retail and Residential.

Different sectors of the REIT market can behave very differently in the same market condition.

Some REITs are seasonal, some are geographical, while others are dependent on the government policy and the overall market they are operating in.

There are many factors which can affect a REITs and different sector of the REITs tends to be more vulnerable to certain market condition, while others are more resilient or even grow in that same market condition.

You have to know the sector that your REITs is investing before you can determine what are the factors that will affect your REITs investment.

Types of Real Estate Investment Trust (REITS) by IncomeBuddies.com

As reported in New York Times, Colby Feane, a portfolio strategist at Manning & Napier in Rochester, said:

“When investing in REITs, it’s important to identify the risk factors specific to each company based on their property characteristics, geographic location and the market they operate in.”

As explained in detail in my other post ‘Types of REITs’, there is an trend of focusing on having a balance lifestyle which allows employees to work-from-home.

Certain sectors might start to feel the pressure from such a trend and probably you may want to have a look to see, which sector of REITs might suit you more.

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What are the Benefits of reits?

REITs is a unique form of investment vehicle with many advantages that any other investment vehicles do not provides. Due to these amazing benefits of REITs that make it a very attractive class of investment that many investor loves to invest.

Let’s dive into the few of these stunning benefits of REITs that you may consider when investing on REITs.

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Cash Flow

Similar to bonds, REITs gives the investor a consistent cash flow in the form of dividend. This means that you as an investor will see money flowing into your bank account from time to time.

Who doesn’t love money right?

But REITs have something which bonds doesn’t have. REITs have the potential of capital appreciation.

Which means that, REITs operates like a stock as well.

When you as the investor purchase your REITs at the right price. As the REITs grow, your investment appreciates in value as well.

You don’t only get the benefit of having the opportunity of buy low sell high, your dividend yield usually becomes higher over time.

Money grow in REITs!

Let’s illustrate it with an example:

You bought “ABC REITs” at the price of $1.00 per share which have an dividend yield of 5%.

  • 5% of $1.00 = $0.05 dividend

This means that you will get an annual dividend of $0.05 per share.

Over the time you have invested, the dividend yield for “ABC REIT” stay the same at the rate of 5% per annual. But in the 10-years of investing in “ABC REIT”, the value of the REIT grow to $2.00 per share.

  • 5% of $2.00 = $0.10 dividend

This means that you will get an annual dividend of $0.10 per share.

You bought “ABC REIT” at the price of $1.00 and it grew to $2.00 giving you an capital appreciation value of over 100%. When calculated using the compounding annual growth rate (CAGR) formula, this is calculated to 7.2% growth per year for 10-years. In additional, your previously 5% dividend yield grew after 10 years of investing.

  • Bought at $1.00 per share 10 years ago, and getting $0.10 dividend per share now = 10% dividend yield

You are now getting 10% dividend yield over cost per year!

Not only you multiply your initial investment by 2 (Invest at $1.00, now at $2.00) due to capital appreciation, your dividend yield over cost have multiply by a factor of 2 (Initial dividend at $0.05, now at $0.10)!

This is very different from bonds which the value and the cash payout of bonds doesn’t grow over time.

Thus if you buy bonds, you will miss out the income growth that can be found in REITs.

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Benefits of REITs - Cash Flow

Diversification

REITs is one of the few asset class that offers diversification. This is when your portfolio consist of REITs and other asset classes such as the general equity markets.

Research have shown that REITs and stocks have a relatively low correlation, which means REITs and stocks react to the market condition differently.

Historically, the correlation between REITs and general equity market have an average of 0.55. Correlation of 1 means highly correlated, and any value lower than 1 means less correlated.

With a correlation of 0.55, having REITs in your portfolio will allow you to smooths out the changes in the value of your whole portfolio.

But why does REITs behave so differently from general equity?

There are a few reasons, and one of the most important reasons is that REITs follows a very different cycle from general equity.

Most stocks are driven by the business cycle, where it is dependent on the rise and fall of economic production which is reflected by the GDP of the country.

When the business is growing and the market are optimistic, the price of the stock will generally raise.

But when the business is lacking attractiveness and the market is pessimistic, the price of the stock will fall, eventually this will lead to an recession.

One early sign before recession is by the GDP growth of the country.

While REITs on the other hand is basically an investment on real estate. And real estate have a completely different cycle from the business cycle. This is generally called the real estate cycle.

  • Business cycle lasts for four to five years on average.
  • Real estate cycle often lasts closer to eighteen years.

This huge difference in the length of the cycle means that even when your stock goes down because of the business cycle, your REITs which follows the real estate cycle may slowly climb up in value.

This makes REITs a particularly great investment vehicle to diversify your portfolio.

Benefits of REITs - Diversification

Inflation Protection

Do you know your money decrease in value every single day?

Why?

Because of inflation. That scary monster that eat your money over time.

But what cause inflation?

Inflation is cause by increase of money pumped into the supply which decrease your buying power every now and than.

Simple terms:

A coffee from Starbucks cost $4.00 now may cost $6.00 next year.

And to protect yourself against inflation, investing in REITs might just be the answer!

REITs generally owns real tangible assets such as real estates. These assets provide inflation protection by two main ways.

  1. When inflation rises by 3%, the manager of the REITs can raise the rents on office buildings and the prices of hotel rooms by 3% or even a higher percentage to counter the inflation. This in turn will increase the income you receive.
  2. REITs invested in real estates and thus when inflation raises, generally the price of real estate raises. This appreciation of the prices of the real estate that your REITs own may sometimes even be higher than your inflation rate. This gives you an even higher return on investment for the REITs you bought!

This benefit of having inflation protection is one of the best benefit that REITs have and many other investment vehicles don’t.

Benefits of REITs - Diversification

My Take Away

REITs is indeed an amazing investment vehicle that you may want to consider to be a part of your portfolio.

  • Risk: Unpredictability, Sensitive to interest rate and Sector dependent
  • Benefits: Cash Flow, Diversification and Inflation Protection

With the risk and benefits discussed in this article, hopefully it will help you in understanding more about REITs. Which in turn helps you in making the investment discussion that will be suited for you 

REITs like all investment, there are a certain level of risk.

Investing should always be done after you understand on what you are investing and remember, ‘Never Invest with Borrowed Money’.

Wisdom from the legendary investor Warren Buffett:

“I’ve seen more people fail because of liquor and leverage – leverage being borrowed money. It’s insane to risk what you have and need for something you don’t really need. You will not be way happier if you double your net worth.”

Just knowing the risk and benefit of REITs do not automatically makes you a great investor. REITs is one of the many investing vehicles that you can take to success. You have to learn constantly and understand the game of investing. 

Remember the difference between success and failure is what you know, and what actions you take.

Here are some resources what will help in guiding you to your success.

What guides me in my journey are some of the many books I read for the past years. There also many words of wisdom said by those who have achieve what we want to achieve and to learn from them is the shortcut to our goals.

Taking your First Step is always hardest, But it is the Most Important Step to Greatness

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