Why I sold my rental property to buy REITs instead?
Perhaps the biggest advantage of buying REIT shares rather than rental properties is simplicity. REIT investing allows for sharing in value appreciation and rental income without being involved in the hassle of actually buying, managing and selling property. Diversification is another benefit.
A REIT can purchase real property directly from a seller for cash or for cash and a note. In this case, after the sale, the seller has no ownership interest in the REIT. As an alternative, the seller of property such as dealer, can transfer his property to the REIT in return for REIT shares.
Investing in REITs can be a passive, income-producing alternative to buying property directly. However, investors shouldn't be swayed by large dividend payments since REITs can underperform the market in a rising interest-rate environment.
The Bottom Line
REITs make sense for investors who don't want to operate and manage real estate, as well as for those who don't have the money or can't get the financing to buy real estate. REITs are also a good way for beginner real estate investors to gain some experience with the industry.
The two main types of REITs are equity REITs and mortgage REITs, commonly known as mREITs. Equity REITs generate income through the collection of rent on, and from sales of, the properties they own for the long-term. mREITs invest in mortgages or mortgage securities tied to commercial and/or residential properties.
Because the REIT manages the property, investors are not burdened with the everyday stress of vacancies, tenants, management or repairs. REITs also pay out dividends to investors, providing a reliable passive income stream.
(iii) With respect to property that consists of land or improvements, the REIT has held the property for not less than two years for the production of rental income.
REITs must prioritize short-term income for investors
“They pay out stable dividends, provided the properties are doing well,“ says Stivers, the financial advisor from Florida. In exchange for more ongoing income, REITs have less to invest for future returns than a growth mutual fund or stock.
Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
The problem with REIT investments is the lack of control over the investment, the risk of poor management, and the market volatility affecting returns.
Is it better to own rental property or a REIT?
REITs provide a much simpler way to invest in real estate and earn consistent income through dividends, but they confer less control, and their upside tends to be lower than that of rental properties.
With stocks, it's possible to build a broad portfolio of companies and industries at a fraction of the time and cost of owning a diverse collection of properties. Perhaps the easiest way to get that diversification: Purchase shares in mutual funds, index funds or exchange-traded funds.
CORE FFO PER SHARE | 3-YEAR | 5-YEAR |
---|---|---|
REIT average | 8% | 7% |
S&P 500 average | 11% | 11% |
DIVIDEND PER SHARE | 3-YEAR | 5-YEAR |
Prologis | 14% | 12% |
If the REIT held the property for more than one year, long-term capital gains rates apply; investors in the 10% or 15% tax brackets pay no long-term capital gains taxes, while those in all but the highest income bracket will pay 15%.
Long-term capital gains or losses
This occurs when a REIT sells a property that it has owned for over a year and chose to distribute that income to shareholders. Long-term capital gains are taxed at lower rates than ordinary income and short-term gains.
REITs have been wealth-creating machines over the years. Realty Income, Equity Lifestyle, and Prologis have all outperformed the S&P 500 over the long term. These well-built REITs should continue enriching their investors in the future. They have the potential to turn long-term, consistent investors into millionaires.
With rate cuts on the horizon, many publicly traded REITs have rebounded, and the industry as a whole seems well-poised for a recovery in the coming year.
The net asset value (NAV) is one of the best metrics to use when assessing the value of a real estate investment trust (REIT). A REIT is a security traded like regular stocks that invests solely in real estate holdings, properties, or mortgages.
Whereas REITs pay dividends to investors, real estate funds aim to generate value through the appreciation of the securities they own. REITs are fundamentally a current-income strategy, as they are required to pay out at least 90% of taxable income each year as dividends to shareholders.
Invest at least 75% of its total assets in real estate. Derive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate. Pay at least 90% of its taxable income in the form of shareholder dividends each year.
Can you live off REIT dividends?
Reinvesting REIT dividends can help retirement savers grow their portfolio's investment, and historically steady REIT dividend income can help retirees meet their living expenses.
Unlike many companies however, REIT incomes are not taxed at the corporate level. That means REITs avoid the dreaded “double-taxation” of corporate tax and personal income tax. Instead, REITs are sheltered from corporate taxes so their investors are only taxed once.
Can You Lose Money on a REIT? As with any investment, there is always a risk of loss. Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds.
“I recommend REITs within a managed portfolio,” Devine said, noting that most investors should limit their REIT exposure to between 2 percent and 5 percent of their overall portfolio. Here again, a financial professional can help you determine what percentage of your portfolio you should allocate toward REITs, if any.
Getting started is as simple as opening a brokerage account, which usually takes just a few minutes. Then you'll be able to buy and sell publicly traded REITs just as you would any other stock.
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