It’s funny how sometimes life can provide clues as to how you should manage your finances.
For example, a few years ago, a minor skiing accident showed my lack of investment diversity.
You’re probably scratching your head wondering what I’m talking about. Let me prepare the stage for you.
After exiting the lift in Beaver Creek, Colorado, a child flew out from behind, forcing me to swerve so as not to kill him and me. I fell on my wrist, but luckily it was not a serious injury. As a periodontist, this wrist (and arm) is my source of livelihood.
The incident quickly made me realize that I was relying solely on one income; income from practice.
At that time, the following questions came to my mind:
- What would I do to make money if I broke my wrist?
- How could I support my family if I were permanently injured / disabled?
Too many people I talk to about finance are in the same boat as I was a few years ago relying on only ONE stream of income… Not good.
At that time, our investments were mainly in Vanguard index funds, which were locked in retirement accounts. There was no other investment income or passive income, so something had to be changed.
I decided to find a solution and started by simply researching what the rich are investing in.
And so, I came across statistics that caught my attention:
“More than 90% of millionaires have real estate in their portfolio… “
At the time, I was not investing in real estate and had no idea how it worked. The only property I was familiar with was the purchase of our house in 2005. That’s all.
So I decided to open my closed mind, read books, attend conferences, listen to podcasts, and communicate with real estate investors.
I was pleasantly surprised to learn that I didn’t have to take a second job and become a landlord. There were other options for investing in real estate rather than becoming an active investor.
One of our main goals was to free up more time to spend with the kids before moving to college, and tenant work wasn’t on our list.
Many of us are busy professionals and tend to focus on passive investments that do not take up a lot of our time. Within a passive investing strategy, the two most popular investment opportunities are real estate syndication and real estate investment funds, or REITs.
I’ve discussed real estate syndicates in the past, so today I want to highlight REITs, which are a collection of real estate stocks.
What are real estate stocks?
Real estate stocks can include any publicly traded business stock that affects the real estate market in one form or another, in one form or another.
They can range from:
- real estate brokers
- technology companies
- producers
- retailers
- Developers
- financiers
Here are some examples:
- Zillow
- Home Depot
- Re / Max Holdings
- CBRE Group
- Toll brothers
Buying real estate shares
Investing in stocks is a simple process. This can be done through any online brokerage account. The main benefit of investing in real estate stocks is that you don’t need to have as much money to get started as if you were buying physical property directly.
This can help those who want to get started with real estate, but do not have a large amount of investment yet.
Like buying real estate, finding the best opportunities and investing in real estate stocks will require research and due diligence. If you don’t understand your investment, don’t invest until you understand. Since stock refers to owning a small portion of a business, you should take the time to research that business first.
You can get educated in several ways, such as reading books / blogs and listening to podcasts.
Here are a few questions you should be able to answer to determine whether or not to buy a stock:
- How does the company make money?
- What makes it different from the competition?
- How can you make more money?
- What risk can lead to loss of profits or bankruptcy in the future?
- Does the current stock price seem like a good buy?
What about REITS?
A REIT, or Real Estate Investment Fund, is a company that owns, manages, or finances income-generating real estate. They can be either private or public, with the most popular being the publicly traded REIT.
An example of a REIT is the purchase and management of real estate such as:
- hotels
- self storage
- shopping centers
- health care institutions
- office buildings
- apartments
To attract the average investor to the real estate market, Congress established Real Estate Investment Trusts (REITs) as an amendment to the 1960 cigar excise tax extension.
The sponsors of the bill wanted to replicate the success of the mutual fund industry by making it easier to raise capital in the real estate industry. They achieved this by using a mutual fund capital structure to create a real estate fund.
This allowed those with less capital to invest in diversification and capitalize on the real estate market.
The regulation allows individual investors to buy shares in commercial real estate portfolios that receive income from various properties.
Investors can buy these shares by purchasing shares of individual companies, mutual funds, or exchange-traded funds (ETFs).
This gives investors a relatively easy way to add real estate assets to their portfolios.
In exchange for receiving favorable tax treatment (they can avoid corporate taxation), REITs must distribute 90% of their profits as dividends. Dividend income comes from rental income and capital gains.
Most REITs distribute these returns to their investors on a quarterly basis, making them a convenient way of earning interest for those who want a steady stream of income.
Example REIT
Here’s an example of a popular REIT, the Vanguard Real Estate Index Fund (VGSLX).
According to the Avangard website: This fund invests in real estate investment funds – companies that buy office buildings, hotels and other real estate. REITs often work differently than stocks and bonds, so this fund may offer some diversification in a portfolio already made up of stocks and bonds. The fund can distribute dividend income higher than other funds, but this is not without risk.
Here is a breakdown Portfolio composition:
As you can see below, he invests in a wide variety of different types of REITs, which, at the time of this writing, include over $ 64 billion in assets.
V 10 largest holdings are:
His performance was very impressive: since its inception in 2001, the profit has been just over 10%:
Benefits of buying shares in REIT
- As previously mentioned, REITs must pay at least 90% of their income in the form of dividends… As you can imagine, this is the main reason why investors put their money in them.
- These large payouts will result in the yield is above average, which is great for a dividend investor.
- Unlike owning physical property, REITs are more liquid as you only need to sell your shares in order to cash them out.
- Investing in a REIT helps diversify your portfolio. Several years ago, our investment portfolio accounted for 98% of the stock market. I wanted to change and diversify some part of it, and I did it with the Vanguard Real Estate Index fund. For the most part, a real estate presence can be beneficial for portfolio diversification by offering a different asset class that can act as a counterweight to stocks or bonds.
- Reducing the risk of cash flows: REITs offer attractive risk-adjusted returns and stable cash flow as they are highly diversified with thousands of properties to choose from.
Disadvantages of buying stock on a REIT
- Unfortunately for those who invest in REITs to generate income, there is more serious tax implications… The federal government taxes dividends at a lower rate than ordinary income, but this tax break does not apply to REIT holdings.
- Stock prices may fall when the value of real estate falls.
- Tax inefficiency: When comparing REITs to rental properties, actively managed properties are more tax efficient. Starting from the first year, they can receive depreciation, which can reduce their “income” through non-cash expenses.
- Revenue decreased with a drop in occupancy.
- Raising interest rates reduce profitability.
Are Real Estate Stocks Right For You?
Do you have financial goals? If so, have you thought about how to reduce your risk in the event of injury or permanent disability? What about risk mitigation?
One of the best ways to hedge against these negative situations is with variety in your portfolio. For many other high-income people and for us, real estate helps increase the diversification of our portfolio. Investing in real estate stock allows busy professionals to enjoy the benefits of owning real estate without the hassle of a landlord. It also allows a much smaller amount of money to be invested initially than spending hundreds of thousands (or millions) to buy real estate.
Whether stocks are right for you in the real estate market depends on whether you have the right temperament to handle the up and down stock swings and whether you can identify good businesses to invest in over the long term.
This article originally appeared on Your Money Geek and has been republished with permission.