Investing in real estate can be an excellent way to build long-term wealth. However, buying individual investment properties may not be the best way to go. You'll have to find your own tenants or higher a property manager, and deal with unpredictable expenses like maintenance and evictions. Plus, if your property is unoccupied, even for a little while, you make no money.
By buying shares of real estate investment trusts (REITs) instead, you effectively spread your money across a basket of properties or other real estate-backed assets like mortgages. What this does is mitigate the risk involved, while providing world-class property management and a team of experts deciding which properties to invest in.
Here are three excellent, but very different stocks to invest in real estate today.
Instead of buying just one rental property, why not buy 110,000?
Equity Residential (NYSE:EQR) is a REIT that specializes in large apartment properties. Currently, Equity owns around 400 properties which consist of more than 110,000 individual housing units. This is amazing diversification, as none of your investment is overly dependent on any one properties' performance.
Equity's portfolio is also very geographically diverse, which means the company's performance isn't too dependent on local real estate trends. No more than 15% of Equity's holdings are in any one metropolitan area, and most are in large, stable markets like New York City, Boston, and San Francisco.
Rents have been on the rise across the United States, and apartment vacancy rates at Equity are at just 4%, which is the lowest level in several years. And it doesn't look like this trend will reverse anytime soon, as the recent data points to a lower home-ownership rate among the millennial and echo boomer generations.
According to Equity's latest investor presentation, there will be about four million people turning 20 every year for the rest of the decade, and the company estimates that between 60-70% of these people will become renters.
Maybe commercial real estate is the way to go
Residential real estate certain has its appeal to investors, but there are some unique characteristics of commercial properties that make them very appealing to those seeking steady growth and income. For example, commercial tenants often pick up such expenses as taxes and insurance, which eliminates some of the variable costs associated with residential investment properties.
Best in breed in this space is Realty Income Corporation (NYSE:O), which has delivered absolutely incredible returns for shareholders. In fact, over the 20 years since the company went public, Realty Income has averaged a total return of 17% per year, handily beating the S&P's average of 9.6% during the same time period.
To put this in perspective, consider that a $10,000 investment in Realty Income two decades ago would be worth about $230,000 today, assuming all dividends are reinvested.
Realty Income's strategy is to acquire properties in desirable locations, and then to lease to high-quality national tenants such as Walgreens, FedEx, Dollar General, and LA Fitness. And, there is such a diverse mix of tenants that they represent 47 distinct industries, and no more than 10% of the company's properties are occupied by any one.
Finally, for income-seekers, Realty Income pays a very nice 5.3% yield, which is paid monthly. The company has increased the dividend 77 times in the past two decades, and the company's low debt and strong cash flow should ensure the increases will continue in the future.
Income-seekers with high risk tolerance might prefer mortgages
Unlike REITs that own property, mortgage REITs are not for the faint-hearted. These tend to move in a somewhat volatile manner and can be very sensitive to rapid rises in interest rates.
However, the income potential of these companies is hard to ignore, and Annaly Capital Management (NYSE:NLY) is in a class by itself.
Mortgage REITs basically make their money by borrowing money at a low rate, buying mortgage-backed securities, and pocketing the spread. In order to achieve desirable returns, they use a great deal of leverage. For example, if Annaly can borrow money at 2% and can collect 4% on its mortgages, it pockets the 2% "spread". However, if it uses a 7-to-1 leverage ratio like it has in the past, the return (theoretically) jumps to 14%.
Currently, Annaly's leverage is about 5-to-1, which the company lowered in response to speculation of rising rates. And, as rates stabilize, the company will have a lot of buying power to take advantage of opportunities.
Annaly pays a 10.6% annual yield and just announced that it will keep the dividend where it is for the time being. Because of the deleveraging and profit erosion that came with 2013's interest rate spike, several dividend cuts were necessary, so this is definitely a good sign.
And, if the high yield wasn't enough to make Annaly look attractive, consider that it currently trades for a 15% discount to the value of its assets, which was $13.23 as of the last quarterly report.
Which to buy?
That's a tough question, and the answer depends on your particular income goals and risk tolerance. Even though I love Annaly and its management, I would never advocate throwing a large percentage of your portfolio into the company, simply because of its higher risk level.
A good strategy might be to split an investment among the three companies, as that would give you mostly diverse exposure to property-backed REITs and still some exposure to the high yields offered by leveraged investing in mortgages.
Matthew Frankel owns shares of Annaly Capital Management and Realtyome.. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.