Looking through the flotsam and jetsam of your portfolio? Need a stock to hang onto? Real estate investment trusts (REITs) may provide just the stability you're looking for. Oh, and did I mention they are up 20% for the year? Take a look.
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Contrarian investing? No. Short selling? No. Boring? Yes. Real estate investment trusts (REITs) have been my savior in this time of crisis. The National Association of Real Estate Investment Trust (NAREIT) index is up 19.4% year-to-date and has a 12.7% annualized return for the last 10 years. Not only can REITs provide a safety net in times like these, but it turns out they hold their own over the long-term as well.
REITs are commonly misunderstood and therefore often undervalued. Negative experiences such as the late '80s real estate debacle and poor returns on tax shelter limited partnerships have also scared away investors.
REITs are a creature of the tax code. They were created by Congress in the 1960s as a way for the common man to reap the benefits of real estate ownership such as tax shelters, inflation hedges, and leveraged buying. Prior to the advent of REITs, only the wealthy could capitalize on the many tax loopholes set up around real estate.
For the history of and a good introduction to REITs, visit the National Association of Real Estate Investment Trusts (NAREIT) website.
Here are a few REIT highlights:
Dividends
The current average dividend yield for a REIT is 8.0%. That's cash in your pocket. And probably the best secret about REIT dividends is that they are not all taxable. A brief calculation of last year's 1099s shows that, on average, 18.5% of REIT dividends were a return of capital (ROC). That means that rather than pay tax on the entire dividend, you reduce the basis of your stock by the ROC amount.
For example: You own 100 shares of Real Assets Company (Ticker: REAC) and it pays a 10% dividend and is trading at $25 per share. Assuming a 20% ROC, you pay ordinary income tax on $200 (0.20 x $250) and reduce the basis of your holdings by $50 ($0.50 x 100 shares). When you sell your shares -- assuming, like a good Fool, you hold on to them for more than 12 months -- you pay tax at a the capital gains rate (20%) rather than ordinary income rate (up to 39.6%).
Downside protection
REITs own real assets with real values that you can touch. This creates an inherent downside to their value called net asset value (NAV). NAV is basically the real estate value less any debt. The problem here is pinning down a value. Unlike stocks, real estate is illiquid and its value is determined by the buyer, not the market. It is better to think of real estate within a range of values rather than at a specific value.
Technology and inflation hedge
Some may like this aspect, others may not. Historically the real estate sector has been the best hedge (high negative correlation) to the technology sector. Also, real estate has always been a good hedge to inflation. Should inflation ever return, REITs may be a safe haven.
Lots of room to run
The entire market capitalization of all equity REITs is $138 billion. That's half the market cap of Microsoft (Nasdaq: MSFT). The entire U.S. institutional real estate market is estimated to be worth around $4.0 trillion. REITs are usually classified by sector type -- residential, office, industrial, retail, etc. They only own small percentages of these sectors leaving plenty of room for growth. Retail REITs have the highest sector penetration at around 50%, but other sectors like office and industrial are below 10%.
The Buffet factor
The Oracle of Omaha, Warren Buffett, has been dabbling in REITs for nearly a year now. Some say he likes the dividends, others say he is bottom feeding. Whatever the reason, it never hurts to keep an eye on the holdings of Wall Street's best known buy-and-hold investor.
REITs offer the most efficient and economical method of real estate ownership and I expect the benefits of public, rather than private, ownership will drive REIT growth for years to come. REITs are not for everyone, but they can play a role in an age-old investment strategy known as diversification. Maybe you've heard of it?
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