In our November 2017 passive income and portfolio update and via other forums, I received some questions regarding our asset allocation. I hadn’t yet thought of doing a post on this topic, so I hope it doesn’t disappoint.
As shared previously, roughly 25% of our net worth is currently allocated across real estate exposure. We utilize Real Estate Investment Trusts (REITs). Disclosure: we hold REITs via two primary investments:
- (1) Vanguard REIT Index Fund Admiral Shares (VGSLX) in a Roth IRA.
- (2) Fundrise eREITs, split 50/50 between the Growth eREIT and the Income eREIT in a taxable account.
We only have $3,500 invested in Fundrise since our initial investment 3 months ago, so this post and the details discussed pertain to our REIT index holding. But first, it’s helpful to discuss some of the general aspects of REITs.
As always, do your own thorough research and consult with a qualified professional before deciding to take any action.
Overview of REITs
I’d suggest googling “what are REITs” to read or view one of the 6.5 million results of existing content on REITs. There are numerous great articles and resources on REITs, but here are some interesting points to note.
History and Evolution of REITs
- In the US, REITs have existed since 1960.
- Since the initial creation of REITs, dozens of different types of real estate properties have been listed as or part of REITs:
- The number of countries and/or regions where REITs have been recognized or established continues to grow:
General Types of REITs
Despite the various flavors of properties across numerous industries and locations, REITs generally fall within one of three common types:
- (1) Equity REITs – those that own and/or operate income-producing properties.
- (2) Mortgage REITs – those that lend (among other activities) to real estate owners and/or operators.
- (3) Hybrid REITs – those that have some flavors of both equity and mortgage REITs.
In addition to the generally three common types of REITs, there are also publicly traded and non-publicly traded REITs. Similar to other publicly traded (i.e., via an exchange) assets, publicly traded REITs are generally more liquid than non-publicly traded (i.e., NOT via an exchange) REITs.
Structure of REITs
While REITs can also take on different shapes and arrangements, a typical structure involves multiple real estate industry participants or parties interacting with the REIT. Investors or shareholders face-off with the REIT, while the REIT interacts with other participants in the real estate space.
A general REIT structure might look like the following:
Attributes of REITs
Among other items, here a few additional points to note:
*Taxes – in the US, profits from REITs are not taxed at the corporate level as long as the REITs distribute at least 90% of their taxable income annually to shareholders. While the REIT doesn’t have to pay taxes on profits, the investors or shareholders will generally pay taxes on income received at their respective ordinary income tax levels.
*Liquidity – primarily with public or exchanged traded REITs, investors are able to buy or sell shares of REITs in a similar manner to equities or other securities traded on a public exchange. Non-public traded REITs might have other requirements for withdrawing funds or selling shares.
*Access – related to liquidity, REITs offer investors exposure to real estate with relatively less capital vs. directly buying an actual property which typically requires a larger sum of capital.
*Diversification – while varying, REITs generally own multiple properties and/or types of properties.
*Passive or Indirect Management – properties are managed and/or management is outsourced by the REIT managers – not investors.
For further details on US REITs, checkout the SEC website.
Considerations for How and Why to Use REITs
In July 2009, I read an article in Forbes magazine about REITs. Over 8 years later, it took me about 20 minutes to find the article when thinking to write this post. This article was not my first exposure to REITs, but it piqued my interest which led to additional reading, research, and – eventually – decision & action.
Part of the reason for our personal use of REITs – and current allocation – is our current lack of home ownership. I believe one’s primary residence is not an investment. Plenty has been written on this topic and opinions vary greatly. For us, we consider real estate to be an important part of our respective investment plan.
Here are the primary ways that we try to utilize and invest in REITs.
1) Look for Low Costs
We’ve discussed previously that you can’t decide or set the expense ratio of a mutual fund (or other investments). But you can decide which ones to invest in. As index or passive funds typically have lower fees or expenses than actively managed funds, you’re more likely to be able to save more of your investment and potential earnings.
2) Seek Diversification
To round-out our approach to real estate exposure, we apply our preferred investment method utilized in other areas of our portfolio: indexing.
I’m sure the right property in the right location has the opportunity to do some spectacular things when given the right time and the right circumstances. I’m just not that skilled nor motivated at this time to pursue that type of search effort. Even after identifying and acquiring the prospective property, I don’t have the skills nor motivation to directly manage a property.
Yes, I know we can outsource the management and/or maintenance, but it just doesn’t fit our respective life style preferences at this point in time. It might work for some, but we’re content to be both renters and owners. If we directly purchase a home or investment property in the future, we’d likely consider scaling back our current real estate exposure accordingly.
3) Consider Account Allocation
In general, where one holds a particular asset might have a major impact on his or her investment. We currently hold nearly 99% of our REIT exposure in my Roth IRA at Vanguard. Why?
*Tax Efficiency – we don’t consider REITs to be as tax efficient as other investments because REITs generally get taxed at ordinary personal income tax rates. Depending on one’s time horizon and income bracket, this can potentially have a significant impact on investment returns.
*Funds Accessibility – Roth IRAs permit access to your contributions at any time, but not the gains or earnings (except for certain circumstances) prior to the age of 59 1/2. Who knows, we might utilize the REIT funds in my Roth to purchase a home when we’re ready to buy. It’s a possibility.
*Lack of Funds Accessibility – perhaps odd that I listed fund accessibility right before, but a Roth IRA is a retirement vehicle. So some of the Roth restrictions and the long-term perspective that I take with the funds in my Roth make it tempting to NOT utilize or access the funds prior to retirement.
As mentioned, we recently began investing in Fundrise’s eREITs in a non-retirement account. We might consider moving to their eFunds at some point (more to come on this in the future). Regardless, the majority of our real estate exposure will remain in my Roth IRA via the REIT index fund for the long-term.
Nurturing Prior Seeds into Growing Trees
In our monthly passive income & portfolio updates, we’ve referenced our extremely strong efforts early in our careers to focus on retirement savings. And only retirement savings. This created a gap between now and then (or between today and retirement) with little or no cushion. Not good from an emergency expense perspective.
However, in the last two years, we’ve only contributed $1700 to my Roth IRA ($1400 in 2016 and $300 in 2017). This is primarily because we’ve focused on allocating capital toward building up taxable investments as well as to establish an emergency fund. We’re now starting to see the results of our early focus on retirement saving:
This only captures passive income in the forms of distributions – not investment or market gains on the underlying shares held. The sustained growth feels amazing as we continue to make progress – but it’s a long-term process. It doesn’t happen overnight.
Each quarterly dividend is reinvested; our ultimate goal is to not touch the principal but to only withdraw the income distributions once we reach “traditional” retirement age. Leveraging both tax-free Roth income with our other account types will also enable us to balance the future’s unknown tax landscape.
Overall, we’ve transformed a seed into a small tree that is beginning to feed and grow itself.
Wrapping It Up
We’ve used REITs over last 7-8 years and will continue to do so in the future by:
- Spreading our real estate exposure across multiple regions/cities, industries, and other variables.
- Saving time to enable focus on other goals – whether additional income streams or anything else in life.
- Diversifying our sources of income but not solely for the sake of obtaining higher income.
- Using progress for sustained growth and momentum, while enabling future capital to be redirected elsewhere.
- Creating potential options for buying or other investment opportunities.
Overall, one’s respective outlook depends on so many unique variables for each respective person. Like any investment, one should consider his or her respective needs and unique circumstances prior to investing in any type of security or asset.
Looking Back and – More Importantly – Ahead
After over 10 years since college, we still rent the roof over our heads – the place where we call home. We’re still going to be renting for the next 12 months and likely for a while after that point. Will we rent forever? I don’t know for certain, but most likely not.
I do know one thing for certain: we’ll continue to be long real estate for the long-term. It might not be the place we ourselves call home at the moment or in the future. But someone or something else lives or will be living where we’re owners. We don’t make money off the place we call home; we make money from the places that other people or businesses call home.
It feels good to be a landless landlord as we continue to find our balance.
Readers, do you currently utilize REITs in any way? What role does real estate play in your respective investment plan? Do you currently own any direct properties or are you considering seeking exposure to real estate?