Tech stocks are known for their growth opportunities, and while they can deliver on these fronts -- they can also be very volatile. The tech-heavy Nasdaq Composite is currently rallying after falling close to 15% in early March.
Yet despite their recent comeback, some tech stocks have been left in the dust. As a result, this could be the ideal time for investors to diversify their portfolios by targeting new high-growth opportunities through real estate investment trusts (REITs).
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REITs 101
REITs, pronounced REETs, are a special type of stock that earn income from the management and ownership of real estate or real estate-related securities -- like mortgages, for example. These companies, not unlike other real estate-related stock companies that invest or lease real estate, primarily earn their income from rental or mortgage income. The big difference, however, is that the REIT structure offers the companies favorable tax advantages, like paying zero corporate taxes, among a few other things.
The REIT qualification process is extensive and requires the company to follow strict rules, including paying 90% of its taxable income to investors in the form of dividends. This means investors can often achieve much higher dividend returns than they would get from even the best dividend stocks.
Dividend income with growth, to boot
Most investors think of REITs as dividend stocks, as opposed to growth stocks, but in reality, REITs can be both. There are several REITs that have achieved incredible growth since their IPOs, making investors lots of money while rising and paying a solid dividend.
For example, Innovative Industrial Properties (IIPR -0.17%), which uses a special sale-leaseback structure to purchase and rent industrial properties to medical-marijuana operators, has seen share prices climb 980% since its initial public offering (IPO) in 2016, while paying dividends in the range of a 1% to 5% yield.
Digital Realty Trust (DLR 0.95%), which owns and operates data center facilities across the globe, has seen its share prices grow 514% in the past 10 years.Reliable dividend income is definitely the main draw to REITs, but investors shouldn't discount their growth potential.
Diversification into real estate
Another huge benefit of investing in REITs is the diversification it offers investors. Today's tech pullback is a perfect example of how being too focused on a singular asset class can put your portfolio at risk. REITs, by nature, offer diversification through the real estate market and are impacted by completely different factors than the stock market. Real estate also provides a hedge against inflation, something tech stocks can't offer.
REITs also provide more stability in their growth prospects and dividend returns. Many tech stocks, particularly newer ones that operate at a loss, mean investors are relying on a company's growth and the ability of management to realize its vision in order to have a payday. Plus, new technologies, increased competition, or waning interest in the technology could render the hottest new tech stock obsolete. All of this means the investor may be carrying more risk for a payday that may or may not come.
However, since REITs earn income from real estate, their profitability and returns are much more reliable and consistent. Investors aren't relying on the idea or vision of the company in order to get a payday -- its current performance is.
Of course, REITs have their own share of market susceptibility, which includes impacts from reduced demand because of oversupply, supply-chain issues, or economic recession. But generally speaking, real estate bounces back, and most types of real estate will always be needed.
Today's volatility equals new opportunities
Thanks to recent market volatility, several high-quality REITs are being traded at a discount. Most REITs right now are trading around 18 to 29 times their funds from operation (FFO) -- a metric that illustrates the REITs' profitability, similarly to earnings per share (EPS). A popular tech stock can trade upwards of several hundred times its earnings, making REITs a major value buy, comparatively.
Several real estate industries are seeing record demand right now, despite uncertainties in the economy, making today the ideal time to buy REITs.
