Land(less) Landlording: How and Why We Use REITs

In our November 2017 passive income and portfolio update and via other forums, I received some questions regarding our asset allocation. A large portion is in Real Estate related assets – especially REITS.

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:

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 the existing content on REITs. T

here 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:
REITs can encompass numerous types of properties from various industries. Source: Nareit
  • The number of countries and/or regions where REITs have been recognized or established continues to grow:
REITs continue to become available in countries and regions across the world. Source: Nareit

General Types of REITs

Despite the various flavors of properties across numerous industries and locations, REITs generally fall within one of three common types:

Equity REITs

Those that own and/or operate income-producing properties.

Mortgage REITs

Those that lend (among other activities) to real estate owners and/or operators.

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 REITs 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:

A General REIT Structure and Interactions
REITs come in different types and structures, but they provide investors exposure to real estate managed by other parties and participants in the real estate space. Source: MoneySENSE

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/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, check out 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 homeownership. 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.

Vanguard Real Estate Index Fun Expenses
Source: Morningstar

Related: How We Got To Averaging +$1,000 a Month In Passive Income

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 lifestyle preferences at this point in time.

It might work for some, but I’m content to be both a renter and owner.

I directly purchase a home or investment property in the future, I’d likely consider scaling back our current real estate exposure accordingly.

Related: 10 Years Lost? Our Renting Remorse(lessness)

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.

Related: 5 Ways to Balance Account Types To Balance Life’s (Un)known Milestones

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.

Related: FTW! Is it Possible to Invest for Today AND Tomorrow?

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 establishing an emergency fund.

We’re now starting to see the results of our early focus on retirement saving via REITs:

REIT dividend payment history for Balanced Dividends.
My REIT dividend income in my Roth IRA. Updated following our final dividend distribution in Dec 2017.

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 the “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.

Balanced Dividends REIT Growth Chart
Visual trending of our REIT dividend income from my Roth IRA. Updated following our final dividend distribution in Dec 2017. Source: Balanced Dividends

Overall, we’ve transformed a seed into a small tree that is beginning to feed and grow itself.

Related: 6-Month Update: Fundrise Passive Income Review

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?


Related:

5 Ways to Balance Account Types To Balance Life’s (Un)known Milestones

FTW! Is it Possible to Invest for Today AND Tomorrow?

How We Got To Averaging +$1,000 a Month In Passive Income


 

MoneyMade
Looking for Top Passive Income & Investing ideas and strategies?
I use MoneyMade to explore new ideas, find the best services, and discover new platforms.

SUBSCRIBE VIA EMAIL

* indicates required

Our favorite free financial tool is Personal Capital. We use it to track our net worth, manage our spending & savings, and to monitor our investments. It’s simple and free to use.

Disclosure & Disclaimer

Please remember, all content found on this website is provided for general informational or entertainment purposes only. This content should NOT be considered direction or advice.  You should always consult a qualified and certified professional for your unique circumstances or specific situation. For more details, please view our Disclosures page.

18 Replies to “Land(less) Landlording: How and Why We Use REITs”

  1. we own a big house. part of the good is that mrs. me bought it for less than 100k 17 years ago. probably could sell for 400 now. we don’t really see it as an investment but it’s paid off and mary begley required a studio space in order to be a painter. this is non-negotiable as it means that much to her and it was cheap. it’s also handy if you’re a dog owner and don’t have to ask permission for anything as an owner or take any crap from anyone like a landlord.

    the downside is the place routinely costs us about 7000/year in maint. and taxes. and this year was the kick in the ass of needing a roof to the tune of about 35k. so there’s that. and remember that property appreciation only matter if/when you sell, as much as folks salivate over net worth on paper.

    we’ve got some reits in a 401 but maybe only 5-7% of our holdings. however, we have about 15% of the ol’ nest egg in preferred etf’s, which we’ve discussed before. one of those yields us over 500 a month reinvested, which is nice.

    hey, that’s pretty sweet capital appreciation on those shares since ’10. looks like about a double from the chart plus the yield.

    1. Hey Freddy – thanks for the comments.

      Congrats on the house; a 300% appreciation in 17 years is nice to have if you ever needed / wanted to sell. Good point about maintenance and taxes; we often forget about that as part of the cost of owning or buying a place.

      Regarding the chart we shared, we did continue to make Roth contributions throughout that timeline – especially when the market was still down in 2010 etc. from where it is today.

      – Mike

      1. mike. i meant to add in to the comment that the appreciation on the house was pure luck. we needed a place to live and this one was cheap, but we’ll take it.

        looks like you’re on solid ground with all this adulting stuff. we got a late start!

  2. High Mike, This is a nice review of the REIT sector. You can’t go wrong with the Vanguard fund in my opinion. Outside of our primary residence, REITs are how I get some additional exposure to real estate. I mainly do it through individual stocks as part of my dividend stock portfolio. I always hold them in an IRA since their distributions are taxed as ordinary income as you mention. Reality Income (O) has been a strong performer for me. I got burned by holding a couple mortgage REITs going into the financial crisis and I have avoided them ever since. Thanks for the post. Tom

    1. Hi Tom – thanks for the feedback.

      The Vanguard REIT fund works well for our purposes. There are still other quality REITs and/or funds available elsewhere though – depends on what you’re looking for exactly. “The monthly dividend company” is a solid name and good choice for many. Thanks for mentioning your experience with the mortgage REITs; I’ve known a few who’ve done well with them, but many, many more who’ve done very poorly.

  3. I really like REITs. Doesn’t cost as much as if you were to buy physical property yourself. You don’t have to bother with the maintenance and being a landlord. They also tend to pay higher yields since they have to pay their shareholders so much percent as you mentioned. Some great REIT companies like O pay out dividends monthly which is great for compounding. Just have to be OK with being taxed at a higher rate for these dividends. But they help to expand your forward dividend numbers and passive income so I think its worth it.

    1. Hi Dividend – thanks for your comments and input.

      Agreed regarding O. Like Tom mentioned, Reality Income can be a strong performer. And you’re correct regarding the compounding opportunities of monthly dividends. The ordinary income tax rates due come into play though depending on one’s respective income tax bracket. As mentioned in the post, this is why we currently hold our REIT holding (which includes O via the index but still pays out as part of the fund’s quarterly distributions) in a retirement account to avoid the tax drag.

      I also just checked out your site and will be following going forward. Thanks again for sharing your thoughts.

  4. I invest in the Vanguard REIT Index fund which is held in my IRA. The past couple years, I’ve started to invest in commercial real estate. Initially through crowdfunding, but now going direct to sponsor. Still learning a lot, and as I get more comfortable with it, I will allocate more of my portfolio to CRE. The most important thing is to pick the right sponsors.

    1. Hi MD – I just viewed your site today; nice post on your initial crowdfund deal. Also, good point about the sponsor. What portion of your net worth is currently across real estate exposure? – Mike

      1. Hi Mike, my real estate allocation is approximately 30%. That includes crowdfund syndication, REITs, and single family rental property. Thanks for stopping by my site.

  5. Hi Mike,

    Very nice review of REITs. I especially like the chart of REIT structure.

    I’m quite heavily invested in REITs, about 28% of my taxable dividend portfolio is in REITs. Manly blue chip REITs like O, DLR, VTR, HCN and a few more.

    In my IRA account, I also invest in VNQ which is one of the popular Vanguard REIT ETFs.

    Nice blog and I’ll sure to check out rest of it.

    Thanks,
    Mr. ATM

    1. Hi Mr. ATM –

      Thanks very much for the comments. You have a nice mix of quality names in your REIT portfolio – plus the wide coverage of VNQ as well (essentially a mirror of the holdings in the fund-version we use from Vanguard).

      It’s interesting to see what % of real estate (whether REIT, direct, or the newer crowdfunding) people have in their portfolios. Just curious – what percentage of your overall portfolio is in REITs
      / real estate exposure across your various account types?

      I also just checked out your site – congrats on your retirement and becoming a full-time investor. Your magic heat map was also very interesting.

      Thanks again.

  6. Hey Mike,

    I agree that REITs can be a great addition to anyone’s portfolio. I have to be honest though I think that REITs are to connected to the stock market in terms of correlation. I would rather have some sort of direct ownership in real estate then participate in REITs. I understand the allure but I would rather put the extra part time job effort into owning rental real estate. My 2 cents doesn’t mean it is right! Great write up.

    1. Hey DM –

      You’re absolutely right – REITs, especially publicly traded, are connected to the stock/equity market in terms of correlation. Investors are purchasing shares/stock of the companies – REITs – that invest in real estate. So there is certainly a close correlation.

      That said, non-publicly traded REITs or crowdfunded deals arguably have a lower correlation to the equity market vs. traditional REITs. But the correlation is still there. Considering the liquidity, time-horizon, and other investment parameters of non-publicly traded REITs (vs. publicly traded), one has a few different options or choices. Overall, the correlation will vary depending on the scope of time, typically being lower over longer periods. But this can also vary greatly depending on the period.

      Direct real estate certainly makes sense. As mentioned, we’ve never owned a primary residence yet, but we’ll likely some day. Likewise, I have interest in owning a direct piece of real estate as a rental property. Whenever we do invest, we’d evaluate and likely scale down the REIT exposure to align with the shift in our exposure as a result of the direct property.

      Thanks for your feedback and view point 🙂

  7. Thanks for the overview Mike. Yes, REITs are a good way to invest in RE without the land/home/tenants/hassle :-).

    It’s also an affordable way in case you don’t want to shell out hundreds of thousands or millions depending on where you live, just to buy one house.

    99to1percent recently posted: What Do You Do For A Living?
    https://99to1percent.com/what-do-you-do-living/

Leave a Reply