Without getting too technical, think of a REIT as something like a mutual fund that invests in real estate, and derives the lion's share of its income from renting that real estate out, usually to other businesses. It's a way for you and me to own real estate without the hassles of being a landlord. No leases to sign. No phone calls in the middle of the night to come fix the leaky toilet. No long-term financial commitment to a piece of ground or a building. Just a share in the profits.
Why invest in REITs? I'll give you 5 reasons.
Superior returns
REITs have historically earned slightly better returns than stocks. I thought stocks were the all-time champions, didn't you? But from 1972, when REITs first began being tracked as a sector, through 2021 -- a period of 50 years -- equity REITs returned an average of 13.5% to investors, while stocks returned 13.1% as measured by the Standard & Poor's index.
Image Source: Getty Images.
Less volatility
REITs are less volatile than common stocks. The ride is much smoother. Although REITs go through sell-off periods just like all other asset classes, the ups and downs are less severe. So if stocks are a roller coaster, REITs are more like a water slide: still fun and adventurous, but smoother and slower, with less extreme ups and downs.
Generous dividends
REITs on average pay higher dividends than ordinary stocks. This means a more consistent stream of income for you and me, the investors. In fact, REITs are required by law to pay out at least 90% of their annual taxable income as dividends. In exchange, they get a dividend-paid deduction from corporate tax for every dollar they distribute, and you and I get a nice flow of cash. Sound like a good deal?
Great retirement benefits
REIT dividends grow tax-free in a Roth IRA. No matter how much cash your REIT investments generate in your Roth, you don't pay a penny in taxes until the day you withdraw the money, on two conditions. First, you must be at least 59.5 years old when you begin withdrawing, and second, your Roth IRA must be at least 5 years old.
Easier than other real estate investing vehicles
REITs offer significant convenience, compared to other ways of investing in real estate. REITs are bought and sold like stocks. You can buy in or sell out any time you like, with the click of a button. This is not true of land or buildings. When you buy land or buildings, typically you make a long-term commitment, sign a mortgage, and pay interest. Then when you want to sell, it's usually a lengthy and complicated process, involving agents who get a cut of the proceeds, and lots of governmental rules and regulations. Simply put, real estate is illiquid, hard to convert into cash. Investing in REITs, on the other hand, involves very little time and effort.
So there you have it: better returns with less volatility, more stability for your investment capital, a richer income stream than ordinary stocks or bonds, a counterbalance for your portfolio when stocks are selling off, and the convenience of instant liquidity. What's not to like?
That's why I allocate a large portion of my holdings to REITs, alongside other stocks and ETFs. Maybe you should too.
