“Property owners get rich in their sleep void of risks, work or economizing.” – John Stuart Mill (political economist)
The above quote holds for investors who turn to REITs as a long-term solution to the ever-present search for lucrative income streams.
REITs – an acronym for Real Estate Investment Trusts – have turned in about 12% average annual returns since 1998 to date, with substantial dividends paid out to investors along the way.
This does well when compared to the average market’s return of approximately 10% over time.
So how do you turn REITs into a substantial income stream? We’ll look at 5 ways but first, let’s understand what a REIT is.
What’s a REIT?
A REIT is a tax-advantaged organization with investments in real estate. In exchange for the company’s tax freedom, the law mandates REIT firms to pay investors 90% dividends from their taxable income.
These payouts are what make REITs popular among seasoned investors, as well as their high market yields.
REITs must also gain 75% of their gross income from real estate mortgage interests or rents and have 75% of their assets invested in real estate.
REITs are in every real estate sector including:
- Single-family building
- Data centers
- Medical buildings
- Cell towers
- Apartment buildings
Those are just some of the major categories, as REITs can own all forms of real estate. But they do tend to choose specific sectors, to enable the executives to utilize their professional connections and expertise of the sector.
Plus investors opt for focused companies in higher numbers than diversified businesses.
How do REITs Stay in Business?
REITs pull in income in two ways: by financing real estate mortgages and by managing and investing in properties. And based on this distinction, there are two major types of REITs:
Mortgage REITs: This REIT type has mortgages on real estate assets and receives payments or interest on the financing of such properties.
Equity REITs: This REIT type directly owns stakes in real estate asset, collects rents regularly and maintains its properties like the traditional property owner.
Most REITs borrow cash to purchase their properties as the regular homeowner would. However, due to their consistent cash flow from various payments and rents, they’re able to borrow substantial amounts safely.
The loans permit them to gain higher income than otherwise.
How to Use REITs Investing as a Business Income Stream
Here are 5 various ways that you can dive into the REITs world:
These REITs manage and own residential properties, specifically multi-family rentals and manufactured housing. In 2018, the United States apartment REITs outperformed S&P 500 and the broader REIT sector with dividend yields averaging 3.97%.
When seeking to invest in this REIT type, you’d want to consider various factors before diving in.
For example, quality apartment markets tend to be in locations with low home affordability in comparison to the rest of the country. In major economic cities, single homes are costly which forces a large percentage of people in the city of rent, and this, in turn, boosts the price property owners can charge per month.
Due to this, the largest residential REITs focus on major urban centers.
In each niche, as an investor, you should look out for job growth and popularity. Typically, a huge influx of people into a city means that there are jobs readily available alongside a booming economy.
Dropping vacant rates occurring side by side with an increase in rents is a positive sign of demand improvement. As far as apartment demand stays high and supply stays low, residential REITs should perform excellently.
And as with most organization’s those with the largest available capital and strong balance sheets perform well.
More REIT investments occur in mortgages rather than real estate itself. However, simply because Mortgage REITs invest in mortgages and not equity does not mean it’s void of risk.
A rise in interest rates would automatically mean a drop in mortgages, pushing stock prices down. Also, mortgage REITs acquire a huge portion of their capital via unsecured and secured debt offerings. If there’s an increase in interest rates, subsequent financing will become more costly, decreasing the worth of a portfolio of loans.
In environments with low-interest rates, and prospective rise in rates a lot of mortgage REITs would trade at discounts to net asset value for each share. The secret is in locating the right one.
About 24% of REIT investments are in freestanding retail and shopping malls. And this represents the largest REITs investment type globally.
The Singapore retail REITs for example in 2018 outperformed the benchmark indices by 5.6%. Check out the best Singapore REITs in 2019.
If you’re considering investing in retail real estate, you have to examine the industry itself. How financially healthy is at present and what its future outlook?
It’s crucial to state that retail REITs make cash from the rent charged to tenants. If retailers have cash flow challenges because of low sales, it’s likely that they’ll default or delay in keeping up with their rent, and probably end in bankruptcy.
When that happens, new tenants need to be gotten, which isn’t easy. So it’s vital that you opt for retail REITs with powerful anchor tenants. This is inclusive of home improvement and grocery stores.
After you’ve done your industry assessment, your next line of focus should be the REIT itself. Just like in other investments, it’s vital that they show good profits with strong balance sheets as well as have minimal debts, particularly for short term debts.
In poor economies, retail REITs with strong cash positions are able to purchase quality real estate at distress prices. Companies with the best managers will take advantage of this.
With that said, keep in mind that retail REITs do possess certain long-term concerns as purchases keep shifting to the digital space as opposed to the traditional mall model.
However, owners of space have consistently embraced innovations to fill their space with other non-retail tenants and offices, but the risk factor is that the traditional retail sector is facing pressure.
Healthcare REITs is an interesting sub-sector to look out for as healthcare costs continue to rise globally.
And here’s why:
“The healthcare sub-industry in Singapore has an average dividend yield of 6.55% which is the 3rd highest REIT dividend yield in the nation.”
These type of REITs invest in the real estate of medical centers, retirement homes, nursing facilities, and hospitals. How well this real estate does for investors depends on the healthcare system.
Here’s more info on Singapore healthcare REITs performance:
Most operators of these facilities depend heavily on occupancy costs, Medicaid and Medicare reimbursements as well as payments of individuals. As far as, there’s a question mark hanging over healthcare funding, there’s one over healthcare REITs as well.
So before investing in a healthcare REIT lookout for varying customer groups and variations of properties invested in. While the focus is great to some extent so is diversifying your risks.
Typically, a rise in health care demand (which usually happens in an aging population) is great for healthcare REITs.
These kinds of REITs invest in corporate buildings. They get income from the rent they charge tenants who usually have long-term leases with them. If you opt for investing in office REITs, ensure that you find out the answers to these questions:
- What are the vacancy numbers like?
- What’s the size of its capital for acquisitions?
- What’s the economic progress of the location of the REIT property?
- How’s the economy doing and what’s the unemployment rate of the property location?
Look out for REITs that purpose properties in economic strongholds of nations. For instance, it’s better to purchase average buildings in an urban center than to have topnotch office space in a small city.
What to Keep in Mind When Accessing REITs for Investment
- Look out for companies with historical data proving that they offer high dividend yields alongside average long-term capital appreciation.
- Most REITs unlike traditional real estate trade on stock exchanges and this permits the diversification of real estate void of long-term lock-ins. Liquidity is crucial.
- Quality management is vital. Search for companies with proven track records and an experienced management team.
- Instead of going the dividend investors route by using payout ratio to access a REIT, look out for its funds from operations (FFO). This is the net income less the sale of any real estate in a particular year and depreciation. So divide the dividend per share by the FFO per share. The greater the yield the better.
- Consider purchasing an ETF or mutual fund with investment in REITs and hand over the buying and researching to the pros.
REITs offer massive investment opportunities but require that you know how to make the right moves to turn it into a lucrative business income stream. With the tips and strategies listed in this piece, you’ll be able to do just that.
What REITs sub-sector do you want to invest in?