Passive income, according to the IRS, is money you make from trade or business activities in which you don't materially participate. In other words, you don't actually manage the business yourself.
What you are doing is putting your money to work, of course, enjoying income that others are responsible for generating. Real estate investing is a great example, and as far as the stock market goes, real estate investment trusts (REITs) are an ideal vehicle for actively generating passive income, especially now.
REITs, each in their own way, are engaged in owning, operating, leasing, and financing income-producing property. What they all share is the requirement to generate at least 75% of their income from real estate activities and to pay out at least 90% of their taxable income to shareholders in the form of dividends.
Stocks that pay dividends are generally regarded as more likely to outperform in a market downturn, and REITs are stocks that are required to pay dividends. Here are six more reasons to consider REITs for part of your portfolio.
1. Low correlation to other investments
As essentially real estate investments, REITs tend to have low correlation to other stock-market sectors, especially when the overall market is tanking, according to data from Nareit, the big REIT industry trade group. That can buffer the falls but also limit the leaps when things turn around. But then, there's income.
2. Long-term performance
REITs have proven to be strong long-term performers. For instance, as of 2021, the FTSE Nareit All Equity REITs index posted average annual gains of 10.29% over 10 years, compared with 14.90% for the Russell 1000 index of large-cap stocks and 3.39% for the Bloomberg Barclays U.S. Aggregate Bond index. Some individual REITs have done significantly better than that. For instance, stock in mobile-phone tower operator Crown Castle International (CCI -1.20%) is yielding about 3.2% on a share price of about $180, which is OK, but it's also posted compound annual growth in total return of 16.5% over that same decade. (Total return is share price appreciation plus dividends.)
3. Stable income
REITs have been providing stable, reliable income through decades of economic swings. One prime example here is Federal Realty Investment Trust (FRT -2.32%), a specialist in upscale retail and mixed-use centers whose stock is yielding about 3.4% at a share price of about $127. More impressive, this REIT has earned designation as a Dividend King for raising its payout every year for more than 50 years. While that's the exception, most REITs do have good records of consistent payouts, and their records are easy to determine.
Publicly traded REITs are regulated by the Securities and Exchange Commission and follow the same rules of transparency as any other member of their respective exchange. (Most are listed on the New York Stock Exchange.) That means their reports and presentations -- including their financials and portfolio holdings -- are easy to find and understand. The best place to start is in the "investor relations" or equivalent section on a company's website.
5. Liquidity = agility
Only about 225 of the 1,100 or so REITs out there are traded publicly, and the ones that aren't can certainly be attractive investments themselves. But they won't have the liquidity of a publicly traded stock that you can get in and out of pretty much in real time. Although REITs lend themselves to being long-term investments, that kind of agility is still a plus for many.
6. Choices to fight inflation and market downturns
REITs can be found in every major real estate segment, empowering investors to choose sectors that they think will do the best in whatever headwinds or tailwinds the economy is presenting. One to consider now in that regard is Alexandria Real Estate Equities (ARE -1.92%), which specializes in office and lab space for hundreds of tenants big and small and serves as landlord to all three producers of the COVID-19 vaccines on the market now in the U.S. Alexandria stock is currently yielding about 2.4% with a share price of about $197.
REITs can help you roll through the bad times until the good returns
REITs have long been attractive as relatively conservative investments that provide capital appreciation potential and steady income, making them good complements or alternatives to bonds and cash in a portfolio.
In today's beat-up market, that stability may look even more attractive than ever. The share price can fall, and most indeed have as of late, but that income helps ease your portfolio pain as you wait for the market to recover, as it always has. REITs in that sense can be an ideal way to be proactive about passive income.