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Real estate investing for income
The how and why of investing in this popular asset class
Michael Carlin, AIF
Books like “Rich Dad Poor Dad,” and many others, sing the virtues of owning real estate and building a portfolio of income producing investments. It’s not uncommon for clients at or near retirement to own several pieces of either commercial or residential real estate that are being rented out for income to help create a nice return for their total investment portfolios. The question is – what is right and best to create income for clients – especially those at or near retirement? Also, is there another way to participate in the virtues of real estate while generating income and hopefully long-term upside? We will explore in this article.
Additionally, we are going to deal with the income aspect of investing in real estate for the purposes of this article. The art of buying low and selling high is for another time, another article and hopefully a nice byproduct whenever you invest in quality real estate. So, let’s talk about real estate income.
Understanding the risk
With any kind of investment that’s going to generate significant income and hopefully significant long-term returns, you need to understand the risk. One of the biggest downsides of owning a commercial building or piece of residential real estate remains the risk given the number of tenants that you’re collecting income from relative to the number of properties you own.
For example, let’s say you own three residential rental houses and you lose a tenant for six months. This could cut your income by a third or more, which may ruin an entire year’s worth of return on those investments. I have been in the wealth management business for more than 20 years and nothing can destroy a great financial plan like a major interruption in income at the wrong time. Typically, when it is hard to find a tenant, it would not be surprising if the economy was struggling at the same time. Thus, just when the income is needed, it’s not there and the other parts of the portfolio may be struggling as well. All of this means, we need to treat real estate income, especially when there is not large tenant diversity, carefully when making retirement projections.
The same is true if you own commercial property. If you lose a tenant, rarely does a client own enough commercial property to lose a tenant and not get significantly impacted by that loss of income.
The more properties, the more tenants you can rely on for consistent income – the better on all counts. However, owning a large number of individual properties is not always feasible for everyone. To help with this, we recommend institutional selection of the real estate whenever possible. I have seen how institutions typically buy and sell better than an individual, so whenever you can get professional support – go for it. Lastly, institutions can work with smaller dollar amounts which would allow a client to buy into more properties with greater diversity.
Here’s my question – as good as real estate can be long-term for most investors, has the market unwrapped another way to invest in this asset class right now at a bargain? Let’s unpack and explore.
How’s publicly traded real estate doing now?
Investing in real estate is a potential compliment to most investment portfolios as this asset class offers an ability to balance the risk of a traditional stock portfolio. Right now, something that is interesting to look at is the publicly traded real estate investments. If you look toward the stock market at the real estate index, you will see that it had a really rough first quarter of 2018. The first three months of this year, this index was down almost 10%! The drop was largely due to the fear that interest rates were going to go up and make it more expensive for real estate companies to borrow, and this sector sold off sharply. The S&P 500 didn’t do great over the first quarter either, going down by nearly 2.5%.
So, if you’re looking to generate income by investing in real estate, the potential cost of getting into this asset class is relatively lower due to its sharp move downward in the first quarter of the year. In addition to the valuation, there’s a few other things that we think are potentially positive for the real estate investment sector:
- Many believe that the real estate sector will do very well in 2018 thanks to President Trump and the Federal Reserve. The new tax law classifies the REIT (real estate investment trust) as a pass-through investment. What this really means, if hypothetically you’re in the top tax bracket, is the tax on your REIT dividends may drop to 29.6% from 39.6%. There is the potential for money to come back into the real estate sector to take advantage of this tax-favored treatment.
- The dividend yield for holding REIT stocks is now better than it has been in some time. By no means are we suggesting that everyone race out and buy the real estate index. Yet, the yield on this investment is 4.42% as of this writing at the beginning of the second quarter of 2018. In addition, there are a growing host of quality real estate companies that you can buy with dividend yields of 6% or even much more! We often look at trends where people are rushing into or out of parts of the market and try not to invest with the quote unquote herd.
Find the right fit for your portfolio
In conclusion, we think investing in real estate makes sense for most portfolios. Some may do it by owning a real building or residential real estate and renting it out. Others may look at the opportunity to invest in the publicly traded real estate market, especially given some of the good news from Capitol Hill as well as some favorable dividend income that looks better given the recent price movement.
We think investing in publicly traded REITs right now is something that appears interesting, but it doesn’t mean that it couldn’t fall further despite some positives that may hold it up for the remainder of the year. Keep in mind, if we enter into a recession, publicly traded REIT investments are not recession proof. Yet, if the economy keeps plugging along here, odds favor a reversion to the REIT mean average which would be a nice potential income and upside from these levels.
Before investing in real estate, we encourage you to reach out to your investment professional to see if it’s suitable to you. We are happy to provide insight by reviewing your current physical real estate holdings.