I’m receiving a lot of questions about REITs lately. On one side, interest rates are low and investors are concerned about what will happen to the loan structure once the rates go up. On the other, with such low interest rate environment, many REITs look very appealing with their high yield.
I’m also a bit concerned about the future of brick & mortar stores. Many of them are closing as they can’t keep up with online stores. It’s not like a new chain will occupy those empty spaces…. Most stores find their growth online!
To answer as many questions as possible, I’ve done a 4 parts series about REITs. They will be published within the next 2 weeks on this blog. We start today with an introduction to one of the retired most favorite dividend payer.
What are REITs How Do They Work?
First things first, there are 2 types of beasts in this industry:
- Mortgage REIT (which makes money out of buying mortgage debts and mortgage-based securities);
- Equity REIT (which makes money from operating, developing, selling, renting, real estate).
As the market shows, only 10% of Mortgage REIT and all those securities backed mortgage environment are cloudy (remember 2008 anyone?), I’ll keep my money away from this segment. On the other hand, equity REITs can be very appealing if you are looking for a steady income.
A REIT is a type of tax structure enabling the company to not pay taxes in exchange for distributing a high percentage of its profit to shareholders. To be precise, a REIT must distribute 90% of its profit to shareholders to be considered as such. Therefore, REITs are literally passing their rents to shareholders after keeping a small portion for management and mainteÂnance fees (including interest!).
REITs have basically 3 ways to increase benefits to their shareholders: They can raise their rents, manage the property more efficiently, or buy the right property in order to maximize the growth value of each building. As you can see, these 3 ways are directly dependent on interest rates and the general housing economy. If the rates are low, the cost of borrowing is cheap for REITs and they can easily generate income.
The REIT yield has been outperforming bonds while their stock underperforming stocks. You can say that REITs are riskier than most bonds but less volatile (while less performant) than other stock on the market. If you are looking to build a 100% stock portfolio, REITs can be a great addition as it won’t lower your payouts while providing an additional hedge against volatility. It is also not as correlated to the stock market. This is why I say it’s a good match for retirees!
