- Lately, I've been getting quite a few questions
about investing money into REITs.
I have no idea why,
but if I had to guess then it has something to do
with these skyrocketing real estate prices as of late.
In this video,
I'm gonna go through some of the pros and cons
of investing in a REIT,
when it makes sense to do so,
and where you should actually be investing in REITs.
Because if you invest in them in the wrong place,
then it's going to cost you some money.
I also wanted to get an idea
of how an investment portal with a REIT will perform.
So I also, back-tested a couple of different portfolios
to show you how things would have turned out.
After that all of course, give you my final thoughts
on what you should do.
Hey, I'm Jarrad and in this channel,
we talk about investing and financial independence.
A real estate investment trust
is a company that buys, sells and holds physical assets
that sit on some sort of land for, of course,
real estate investing purposes.
Sometimes they're involved in mortgages as well,
but that is a very small amount of them.
There is a ton of different REITs out there.
Some focus on making money through the buy and sell side,
some focus on the buy, hold and rent side,
and some do a little bit of both.
On top of that,
each individual will REIT
will sometimes specialize in a certain sector
within the real estate ecosystem.
Think of things like hospitals, grocery stores,
restaurants, shopping malls,
cell phone towers, office buildings,
casinos, and anything in between.
These REITs are publicly traded on the stock market
for investors like you and me to put our money into,
this is a great way to diversify your overall portfolio
into real estate
without having to handle the day-to-day work
of managing the physical assets.
There's three main reasons people invest in REITs.
The first is to diversify some of your overall portfolio
into a different asset class like real estate.
Because real estate is its own sector,
it's not as closely tied to other stock sectors.
For example, like tech stocks,
such as Apple or automotive stocks like Ford.
So if we see other sectors tanking in price
for whatever reason,
the price of your REITs might be unaffected
or not affected as much.
If we compare a REIT index
to a total stock market index since 1997,
we can see that a REIT index will go through periods
when it outperforms and underperforms the market
during that time.
And if we look at the performance over the past 27 years,
we actually see that returns are pretty darn close
with the total stock market returning
just a little bit more.
A $10,000 investment would have turned into $130,000
if it was all put into REITs,
and $157,000,
if the money was put into the total US stock market.
Will this continue though?
Who knows.
The point of potentially adding a REIT into your portfolio
might be to protect some of your returns
if other investments in your portfolio
underperforms during a certain period of time.
Other than that, if you want a little bit more exposure
to real estate beyond what you currently have,
then a REIT can achieve that for you.
But if you have money invested in a total stock market
or S&P 500 index,
then you already have exposure to real estate
of anywhere between two to 4%.
So keep that in mind before blindly adding a REIT,
because you might already be covered.
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The second reason to add a REIT into your portfolio
is for liquidity.
If you want to invest in real estate,
then you can either buy physical real estate or a REIT.
In my opinion, physical real estate
is the best option of the two.
But the problem with it is that it's not very liquid,
you'll usually need a larger amount of cash
for a down payment.
And there is a steep learning curve.
I can't just go sell my house tomorrow
and have that cash show up in my account that day.
The process takes weeks or even months,
but with the REIT, you have access to your money
as quickly as you can press that sell button
since they are traded on the stock market.
If you were investing in a REIT,
then I'd say that,
you try to treat it like physical real estate,
where you're not trying to get in and out real fast
to make a quick buck.
But it's always nice to know
that you do have access to the cash
if there's an emergency and you need it.
The third reason people love investing in your REITs
is for those sweet, sweet dividends in investor receipts.
REITs are known for paying out pretty healthy dividends
every quarter or sometimes monthly.
This is a great way to get a consistent passive income
stream going,
but don't just go investing
all of your money into REITs
for the passive income through dividends.
I'll explain why in just a minute.
The big reason real estate investment trusts
can pay such high dividends
is because by law
they're required to distribute 90% of their income
after expenses to shareholders.
This rule makes it easier for them
to promise a higher dividend.
On top of that,
these rates are usually receiving a consistent cash flow
from their tenants
and have those tenants locked into longer term leases.
This will translate into a steady stream of cashflow
every single month.
For all of the great things that we can say about REITs,
there's also some downsides as well.
Now these aren't the be all end all reasons
to avoid them altogether,
but it's just things to know about.
If we think about real estate in general,
the price of it is impacted by interest rates
that the Federal Reserve chooses.
Since most of these REITs are going to acquire more assets
through debt,
when interest rates rise,
it becomes more expensive to borrow that money
to purchase additional properties.
The Fed has kept interest rates extremely low
since the housing market crash in 2007,
which has helped increase the price per share
of publicly traded REITs.
If or should I say when they decide
to start increasing REITs again,
we might start to see the price per share
for real estate investment trusts take a hit.
Over the longterm, the return on your REITs will be fine,
but in the short term, it could look a little bumpy.
So just be aware of that.
The other thing that I think is overlooked a lot
by investors is the taxes that you'll pay
for the dividends received from investing in a REIT.
You as an investor will have to pay ordinary income tax
on the dividend distributions
even if you decide to reinvest that money
back into the REIT.
So if based on your income,
you at the top of the 12% tax bracket,
the dividends received from your REITs
could potentially push you into that 22% tax bracket.
While on the surface, this doesn't seem like a big deal
it is from a return perspective.
These taxes you pay
whenever dividends are distributed to you,
can have a tax drag on your portfolio,
which will reduce your overall returns on that investment.
The good news is that there's a little workaround
when it comes to investing in a REIT.
to avoid paying the ordinary income tax every year,
you would wanna hold reinvestments
in a tax advantage account, like a 401(k),
IRA, 403{(b) or even an HSA.
That way you're not getting a tax bill every year
for the dividends that they pay out to you
try to avoid investing in a REIT
or any very high paying dividend stocks
within a taxable investment account,
unless you really know what you're doing
in terms of the tax liability and strategy.
When I see people holding high dividend paying stocks
in a taxable investment account,
it makes me cringe because it's costing them a lot of money
in taxes every single year.
Another thing to keep in mind when picking a REIT,
is don't just choose one because it pays a high dividend.
While high dividends can be great,
if it looks too good to be true, then it most likely is.
You'll need to look deeper into the fundamentals of the REIT
to see if that dividend deal is even sustainable long-term.
If it's not, then they can change it whenever they want.
Here's two examples of REITs that had dividend yields
in the 20% range for a short period of time,
until it eventually came back down.
Doing your due diligence on an individual REIT stock
can be time-consuming and even confusing sometimes.
But the good news is that you can still take advantage
of this investment class using a REIT ETF,
which makes it way easier to evaluate.
A REIT ETF is a fund that holds a bunch
of different individual REITs within it.
So instead of buying, say, Crown Castle,
Store Capital or Simon Property Group stock individually,
you can just buy a REIT ETF
like the Vanguard Real Estate ETF,
which holds those three stocks, plus 170 others as well.
Full disclosure,
I'm a little biased when it comes to ETFs,
because I love them over individual stocks
every single day of the week.
But if you want to invest in the REIT stocks individually,
and you know what you're doing,
then go for it above my head.
And at the end of this video,
we'll have a link to a video
that I made on how to analyze an ETF before you buy it.
When it comes to backtesting
different investment portfolios,
I had to make a few assumptions.
So keep in mind that mileage may vary
based on how you would construct a portfolio on your own.
But this is what I came up with.
Instead of investing a lump sum at once
to see how it would turn out,
I wanted to take a little bit more realistic approach.
Since most of us are going to be investing money
every single month,
I set up the back test to account for that.
I chose $500 per month to simulate
something like Maxine out a Roth IRA every single year.
Because the max contribution limit is $6,000
divided by 12 months.
That makes it 500 per month.
The first portfolio is what I'll call our control portfolio.
I have 100% being invested
in the total stock market like a VTI.
The second portfolio
has 80% in the total stock market and 20% in a REIT ETF.
The third portfolio is a little bit of a play
on the three fund portfolio,
except I pulled out the bonds and replaced it
with a REIT ETF.
For that one, I have 70% in the total stock market,
20% in international and 10% in a REIT ETF.
The returns for all three were within 1% of each other.
The only one that lagged behind the most
was the three fund portfolio.
But that was mainly because
of the 20% international exposure,
which dragged down the returns.
If we had increased the re allocation,
did say 20%,
and dropped the international down to 10%,
then it would have performed just a little bit better.
As always with any sort of backtesting
there is no guarantee
everything will play out the same way going forward.
I personally left my crystal ball
at my ex-girlfriend's house.
And she, of course, won't give it back so,
I can't tell you what the future looks like.
I don't think there's any hard and fast rule
as to whether or not you need to own a REIT.
It's mainly going to be personal preference.
If you feel like you want more exposure to real estate,
then go ahead and invest a certain percentage
of your money into one.
But I probably wouldn't make it a larger allocation
within your portfolio.
Also double check to make sure
that you don't already have money invested into real estate
within your index funds,
because I bet you already do.
This is just my opinion,
but if I had to add a REIT to my portfolio,
then I do it through a REIT ETF
as opposed to picking a REIT stock individually.
But that's just me though.
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