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"Investing in Dividends"
Considering real estate investing but frustrated by the expense and responsibility? Concerned over whether you’re getting accurate data or worried about the impact of rising rates on property returns? Have you considered REITs? Real estate investment trusts (REITs), include a wide variety of real estate, generally furnish substantially higher dividends than common equities, i.e., stock and bonds, and enjoy relatively favorable tax treatment.
REITs are real estate-centered trusts that aim to own cash-generating properties and are publicly traded on a national stock exchange, which enables them to provide investors with a rate of liquidity not typically associated with direct real estate ownership.
“While stocks were generally negative in 2022, real estate tended to hold steady,” said registered investment adviser Jonathan Komich, CFA. “But fast forward and REITs have been affected by inflationary pressures and interest rate sensitivity. Anyone interested in REIT investing needs to be aware of these factors.”
“By purchasing REIT shares you can own real estate that may appreciate over time without the costs and hassles associated with owning, operating and maintaining physical buildings,” said Lawrence Carrel, the author of the recently updated “Investing in Dividends” (For Dummies, 288 pps., $18.84).
With an REIT one does not need to identify promising real estate, make a down payment, get a mortgage, pay insurance premiums, deal with tenants or provide maintenance. Plus unlike owning real estate, REITs are highly liquid. REIT shares can be bought and sold on a stock market in minutes. A typical real estate closing can last an entire afternoon and property can sit on the market for months or longer before a buyer is found. REITs can also provide portfolio diversification thanks to a relatively low correlation between them when compared with the returns of other equities and fixed-income investments. This can potentially reduce a portfolio’s overall volatility vis-à-vis its risk level.
REIT dividends tend to be significant, commonly yielding from 4 to 8 percent. Further, REITs are required to annually distribute at least 90 percent of taxable income to their shareholders. The dividends largely come from rents paid by tenants, but there is a downside to this. “High dividend payouts force REIT management to take on debt to expand real estate holdings,” Carrel noted. “Rising interest rates hurt profitability.”
Consider that equity REITs fell 3.2 percent in May, according to the FTSE Nareit Equity REITs Index (reit.com). On a year-to-date basis, equity REITs are basically flat with a total return of 0.2 percent. Office REITs have recorded the biggest drops in 2023, falling 24.1 percent through May. Positive REIT performers include data centers (up 3.4 percent), single-family rental (up 2.6 percent) and hotels (up 1.3 percent) — not exactly eye-popping returns.
Thinking about commercial office space? Note that in the United States, REIT market exposure to general office space is only about 3 percent. Over half of the REIT market consists of such sectors as self-storage, single-family rental and wireless towers, each of which tend to furnish regular positive if not glamorous earnings. According to the Vanguard Real Estate Index ETF, the average REIT yield is 4.1 percent. Conversely, the S&P 500 Index is up some 10 percent for the same period. Why the flat performance? Rising interest rates and the regional banking crisis have dulled REIT performance.
“Interest rates, valuation gaps, inflation, a tightening of the capital markets, the lending environment, new regulations, new technology, the ability to get funding, the glut of empty office buildings, and the environment for mergers and acquisitions have had an impact,” Carrel said.
“A lot of institutional investors have loaded up on REITs of all asset classes,” Komich said. “This could be a potential headwind, limiting the desire for new deals.”
With locations in Riverhead and Deer Park, Tanger Factory Outlet Centers Inc. (SKT), is a national REIT with a large Long Island presence. At around $20 per share, it has returned about 20 percent this year, steadily rising from its 52-week low of about $13 in the face of a rising interest rate environment. Tanger, which has 40 outlet malls nationwide, pays a quarterly dividend of 4.8 percent. It raised its dividend by 11.3 percent in April after having suspended it during the pandemic. Ratings agency Zacks presently has a “hold” on Tanger but high retail shopping levels are keeping its tenants flush. Tanger generally enjoys an approximately 90 percent tenant-occupancy rate. Low and/or falling occupancy rates and increasing vacancies hurt revenues derived from holding property.
How do publicly traded REITs compare against private REITs and privately held individual real estate? With publicly traded REITs, all of the key data is audited and a matter of public record. When purchasing privately held real estate, investors need to be prepared for surprises stemming from what could be less than crystal-clear information and sloppy or inconsistent record keeping. REITs have delivered 24 percent and 20 percent average annualized returns, respectively, over ensuing three- and five-year periods, outpacing broad equities, bonds and private real estate according to CBRE Investment Management.
