As the stock market continues to linger at all-time highs and rising interest rates put pressure on bond prices, nervous investors continue to look for somewhere to invest for income and hopefully some long term principle appreciation.
An often overlooked asset class that can play an important role in a well-diversified portfolio is real estate. While the idea of your own home being an “investment” continues to be debated, most money managers see the wisdom of investing in some sort of real estate for diversification purposes. But, not everyone is cut out to be a landlord.
Like any investment, owning real estate has its pros and cons. Over the years several people have asked me if they can buy a rental property or other real estate in an IRA or other investment account and although it is theoretically possible, it is extremely complicated and it is very hard to find a custodian company that will sponsor an IRA that can hold actual real estate. A lot can go wrong, so for most people if you want to own real estate other than the home you live in, it is probably better to buy real estate the old fashioned way, hire a real estate agent, buy a piece of land to hold on to for a few years or buy a rental and hire a management company to take care of it for you. But, unless you have a very large portfolio, it is hard to diversify properly with individual real estate; it can be cash intensive upfront and is not very liquid.
For some people, an alternative to buying actual real estate may be to invest in real estate investment trusts, REITS. A REIT is a corporation or other legal entity that invests in income producing real estate or real estate related assets like mortgages. They can invest in a broad range of real estate from malls and shopping centers, to storage companies, apartments, medical facilities, golf courses, hotels and resorts, office buildings, etc. One advantage to investing in REITS vs. individual properties is an investor may be able to diversify into different types of real estate in different geographic areas with much less money than it would take otherwise.
Most REITS produce good income through dividend payments. In fact, to qualify as a REIT, a company has to pass through at least 90% of its taxable income to shareholders. Another possible advantage of REITS is they may offer some level of inflation hedge as the rents of the properties held by the REIT can be increased as inflation rises. REITS don’t perfectly correlate with stocks or bonds meaning if stocks or bonds are going up or down in value, REITS may not follow in perfect lockstep offering something in the portfolio that may zig while other parts zag or vice versa.
There are certainly some advantages that you get from owning a piece of real estate you don’t get from owning a REIT, but if you don’t want to be a landlord, you may want to look to REITS for portfolio diversification and income. In closing it is important to understand that there are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions, so real estate and REITS are not suitable for all investors.