The technology-heavy Nasdaq Composite Index is down 27% through roughly the first six months of 2022. That's way worse than the S&P 500 Index's 20% drop. And while the average real estate investment trust (REIT) is down just as much as the S&P, there's one thing REITs have over that index and the technology stocks that drive the Nasdaq: dividends. Here's why you might want to start adding some REITs to your portfolio today.
Trees don't grow to the sky
When times are good, investors will believe almost anything in an effort to explain skyrocketing stock prices. For example, during the dot-com mania at the turn of the millennium, money-losing companies only had to show that they were getting increasing traffic to their websites to justify lofty stock prices. During the pandemic in 2020, the story was that new technologies would foster a permanent shift online for employees and customers who would do everything at home. Neither of these things panned out -- though, admittedly, the work-from-home issue is still evolving.
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Usually, the names caught up in these types of hype-driven periods are technology-focused. Over the history of the stock market, that's included everything from railroads to autos to photocopiers. What counts as technology today almost doesn't matter tomorrow. At some point, whatever is being hyped as the new thing will eventually hit the wall of reality, be overtaken and fade.
That's not to suggest that you shouldn't own technology stocks, but that you need to temper your expectations and diversify your portfolio. The physical property that REITs own is one important way to do that, but there's more to this story than that.
Dividends, dividends, dividends
Growth-oriented investors tend to overlook the power of dividends, even though dividends historically have accounted for about a third of the S&P 500 Index's total return. Think about that for a second; those boring quarterly payments are anything but trivial when it comes to long-term performance.
REITs, meanwhile, are designed from the ground up to pass income on to investors. In fact, so long as a REIT pays out at least 90% of its taxable income as dividends, it even avoids corporate taxation. Investors pay taxes on this income at their regular tax rate, but that's still a net plus since it avoids the double taxation that most dividends face. And it clearly incentivizes REITs to pay out big dividends.
Meanwhile, if you buy a REIT like STORE Capital (STOR) with a generous 5.8% dividend yield, you are more than halfway home to the historical average 10% annual gain that most investors receive in the stock market. STORE Capital has also increased its dividend annually since its initial public offering (IPO) in 2014, so there's the potential for a growing income stream in REITs, too, if you pick carefully. And since REIT valuations are often associated with their dividend yields, dividend increases usually result in stock price increases, too. Thus a steadily rising dividend often leads to a steadily rising share price.
The best part of REIT dividends during a bear market, however, is that they give you something to watch other than stock prices. Don't underestimate how hard it can be to live through the onslaught of a market downturn. If instead you can shift your view to the income you are generating, you will be able to sleep much better at night. If you reinvest your dividends, you can even note that you are getting more REIT shares at better prices than before, thus improving your future income stream.
REITs aren't a cure-all, but they're still pretty good
None of this is to suggest that you should run out and buy any old REIT. You need to be selective and focus on landlords with strong track records, such as STORE Capital, which kept increasing its dividend right through the 2020 pandemic downturn. And as noted above, REITs will get hit by market downturns just like other investments will. However, the dividends they pay can help you build wealth in good markets and bad while at the same time easing your broader concerns by giving you something other than stock prices to pay attention to. If you haven't looked at the REIT sector before, the current technology meltdown is yet another in a long string of reminders that you should probably consider adding a couple of dividend-paying REITs to your portfolio.
