I've been investing in real estate through ETF's for a while now. It's a great way to get started with only a few hundred dollars.
How to Start Investing in Real Estate With REITs
There are many ways to invest in physical real estate, yet most of them involve large sums of money and committing to one major investment at a time. For most people, one's home is their largest real estate investment and for many it may be enough to worry about. If you are looking to invest more in real estate or diversify your current portfolio, perhaps as part of your Roth or traditional IRA, then there are some great options that can allow you to own physical real estate without the hassle of managing that property.
One way is through a Real Estate Investment Trust (REIT). A REIT is a corporation that must meet the following criteria in the US:
- The REIT company invests at least 75% of its total assets in real estate, cash, or U.S. Treasuries.
- It derives at least 75% of its gross income from collecting rents, from interest on mortgages that finance real property, or from the sale of real estate property.
- It pays no less than 90% of its taxable income to shareholders in the form of dividends each year.
- It is recognized as an entity that is taxable as a corporation.
- It is managed by a board of directors and/or trustees.
- It has at least 100 shareholders.
- No more than 50% of the REIT's shares are held by five or fewer individuals.
For me as an investor, perhaps one of the most appealing things about REIT's is the dividends that they pay, as well as capital appreciation, which is the value of shares rising over time.
According to Zach's Research, over a forty year period from 1972 to 2012, the average annual return from REIT's was 8.09%. For me, that's not a bad track record at all. Of course any investment has risks, and during the financial meltdown of 2009, shares in some REIT's dropped more than 50% overnight. If you were like me and were one of those REIT investors back then, it was a hard pill to swallow. Yet if you had held on to your shares, you would have seen the price come back to pre-crash levels and then continue to grow and earn dividends over the past few years.
What Kinds of REITs Are There?
If I've piqued your interest and you want to invest in your own small real estate empire, then there are plenty of choices. In many cases, individual REIT companies focus on one or two sectors, medical offices and hospitals, for example. Others may buy only property housing cell phone towers, or warehouses used in product distribution or to house computer server farms. There are housing REITs that own apartment complexes and rental homes, as well as ones which own shopping malls and even outdoor advertising signs. It can be almost overwhelming to try and choose the sector that you feel most comfortable with, since each carries its own set of risks.
To make diversification easier, there are ETFs or Exchange Traded Funds, which are sold on the major stock markets, and which themselves contain shares of a number of REIT companies. One of my favorite ETFs is one by Vanguard, the Vanguard Real Estate ETF (VNQ). It has a very reasonable 0.12% expense ratio, and as of 12/20/2020 had an average ten-year return of over 8%. As of the date that I wrote this article, a share of VNQ could be purchased for $86.76.
The barrier for entry in this type of real estate investing is very low, especially now that online brokerage companies such as Charles Schwab have eliminated all fees for buying and selling shares. In some cases the amount to open a brokerage account is as little as $100. If you have earned income, or have a spouse that does, you may be able to invest between $5,000 to $7,000 into a Roth IRA, and then never pay any more taxes on the income and share price appreciation on your investment. In my own case, I invest in ETFs through my Roth IRA. It's as if you only pay tax on the seed, and then are able to harvest fruit from the tree that that grew from that seed tax free, for the rest of your life.
It all may sound good, but is this the best way to invest all of your money? Most financial experts would advise against putting all of your eggs in one basket, and recommend instead that you diversify your savings or retirement over a number of investments, such as bonds, stocks, bank CD's, and even physical gold. As you near retirement age, your investment strategy should get even more conservative, since you have less time to make up for market losses.
Each investing scenario is different, and some advisors suggest at least 10% of a portfolio be invested in real estate. That percentage is similar to my own holdings in REITs and REIT ETFs.
How Do REITs Compare to Actual Real Estate as an Investment?
It is extremely hard to compare investing in a REIT or REIT ETF with buying a piece of physical real estate. For many savvy investors, owning one's own property can be a much more lucrative proposition. If you're able to only use a small amount of your own money to finance a property, and then rent it out for an amount that pays that mortgage each month along with maintenance costs, then you'll have a completely different outcome than if you'd invested the same amount into a REIT. At the end of your mortgage, your tenants would have paid the lion's share of the cost of your investment, minus whatever expenses you had, including your time.
This comparison, REITs versus physical real estate, is an apples-to-oranges comparison. Nevertheless it is rehashed quite a lot on financial sites such as "The Motley Fool" in articles with titles such as "REIT's vs. Owning Your Own Real Estate". While in many incidences you can come out much farther ahead by buying property on your own, the risks are not the same for both assets, and they're simply not directly comparable. For example, your own local real estate market may be due for a major correction, such as that caused from a local employer leaving town, or, perhaps you're unlucky and get tenants who repeatedly do costly property damage to your rentals. (Been there, and had to deal with that myself.) Your rewards, as well as your risks, are concentrated when you own your own properties.
The Vanguard fund we mentioned, VNQ, owns more than 180 different REIT's, which in turn may own hundreds of different properties spread out across hundreds of cities and states. If a downturn were to happen on one area or if a tenant quit paying somewhere, the consequences to your investment wouldn't be as dire as if you owned actual property.
I'm not against owning rental property; I'm very much for it, and have had my own income properties. At this point in my life though, I no longer own any rentals and have no desire anymore to collect rent from late-paying tenants, or worry about the condition of a roof, HVAC, or water heater may be. Also, because of the COVID-19 crisis, the city where I live, Austin, TX has enacted a moratorium on evictions for several months. While I sympathize deeply with the people living in these homes and unable to pay rent, I also sympathize for the landlords, many of whom are small investors who may themselves be having a hard time making mortgage payments on properties where they haven't collected any rent on in months.
For my own peace of mind I choose to keep my retirement fund diversified among several different classes of assets, including REIT ETF's, rather than have to deal with tenants as I get older. If you understand the risks, and would like another way to diversify your investments, you might consider adding REIT's and REIT ETF's to your own portfolio. As with any investment, though, consult with your investment professional first before making any decisions.
Sources for this article include:
Zacks Research, http://www.zacks.com/stock/news/100195/REITs-Breakthrough-Real-or-Bubble
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2020 Nolen Hart
Peggy Woods from Houston, Texas on December 21, 2020:
Diversification is the way to go when investing. Thanks for showing us what you are doing with your real estate investments.