Pros and Cons of Investing in REITs

For anyone of you not familiar with this exclusive income-driven asset category, Real Estate Investment Trusts (REITs) are generally corporations which own real estate assets like land, buildings and also real estate securities. Almost all companies in this industry earn their income by buying real estate assets and then renting or leasing them out to individuals and organizations; while others just invest in real-estate-related securities like mortgage bonds and lend capital to create funding for third-party real estate projects.
Let us begin with an instant explanation of the pros and cons related to investing in REITs.
 

Pros of Investing in Real Estate

  • As a way to meet the criteria as a REIT for tax purposes, a corporation must give back a minimum of 90 percent of profits to the shareholders as dividends. As a result, the average REIT claims an approximately 6 percent annual dividend yield. This is the first advantage.
  • REITs may not be as remarkably correlated with the main indices as the majority of industries are. Therefore, they may give your personal portfolio with certain much-desired diversification and should be useful to smooth out your all-round returns, especially during market downturns. This could be an added advantage for investors who do not have big risk appetite.
  • REITs possess hard, tangible assets like land and buildings. They usually sign long-term lease agreements with their tenants. As a result, REITs are often having the advantage of being among the most secure corporations on the market. 

Cons of Investing in Real Estate

  • Since they can just reinvest not more than 10 percent of their annual earnings back to their main business lines every year, nearly all REITs usually grow at weaker clip compared to regular stocks. Track record has indicated that the typical publicly traded REIT has a tendency to publish annual profits growth at certain percentage points under that of the S&P 500. It is quite an obvious disadvantages.
  • Even though the business is often a pretty secure one, REITs are certainly not without risk. For instance, the dividend payments usually are not guaranteed plus the market is vulnerable to cyclical downturns. However, for most investors, this is not consider a significant disadvantage.
  • Given that they already have an exclusive tax-advantaged status compared to various other companies (they are permitted to deduct the payouts from the taxable profits), from an investor's point of view, about two-thirds of dividends paid out by REITs will not be entitled to the lower 15% tax rate. 

Things to Consider in REITs


When investing in REITs, start by taking a look at the same important factors which you study for some other equity investments. You may look for corporations with strong track records, successful management groups, fair valuations and good growth potential. Along with this evaluation, serious REIT investors must also seriously consider:

Geographic Diversification

Huge, widely diversified corporations have lower exposure to local or regional economic weakness and natural disasters compared to their smaller counterparts.

Current Dividend Returns

When you invest in REITs, search for stocks which pay out above-average annual returns of no less than 6%.

Long-Term Dividend Growth

Also consider organizations with lengthy track records of steady, growing dividends.

Dividend Payout Ratios

It is possible to calculate this ratio if you take a company's yearly dividend payment for every share and dividing the amount by its earnings per share. This payout ratio provides an evaluation of the percentage of earnings a corporation pays out as dividends. Seeing that REITs must pay out a minimum of 90 percent of their profits as dividends, a large number of these corporations hold a fairly high payout ratio. Nevertheless, sometimes a corporation may pay out more than 100 percent of present earnings as dividends. Considering that this kind of payout ratio is usually unsustainable over the long period, a number of these corporations are ultimately forced to reduce their dividends. Consequently, when looking for high-quality REITs, seek out organizations with payout ratios down below 100 percent.

Is There any DRIP Available?

You would also want to know if a specific corporation provides a dividend reinvestment plan (DRIP). Amongst the many advantages, these kinds of plans easily reduce or eliminate the particular transaction fees in which one would normally need to incur as a way to reinvest his dividend back to the underlying stock.
 

Things to be Cautious About When Investing in REITs


The most frequent mistake which REIT investors commit is to target solely on dividend yields. Right after looking for as well as investing in those corporations that provide the highest yields out there, a lot of investors sit back and await the money to roll in... blindly. The problem using this approach, certainly, is the fact that corporate dividend payments are never guaranteed. All those investors who buy a specific REIT just due to the current dividend yield could possibly be setting themselves up for great disappointment.

More on Real Estate Investment