The quickest way to get rich on Wall Street is to buy one investment that goes up like a rocket ship. The problem with this approach is that nobody knows which stock that will be, and therefore such a concentrated approach is also the quickest way to lose a lot of money.
A far better way to go about things is to diversify your portfolio and dedicate a portion to income-producing stocks in addition to growth opportunities. Real estate stocks offer particularly promising opportunities for passive income. Let's take a look at a few reasons why that's the case.
Image source: Getty Images.
Investing in real estate is easier than you think
One of the most notable things about real estate is that it is hyper-local and, usually, expensive to invest in at the property level. That's particularly true for institutional-size properties, like apartments, warehouses, offices, retail, and industrial buildings.
But the good news is that you don't have to buy a portfolio of individual properties. Instead, you can just buy a real estate investment trust (REIT), which is a company specifically designed to invest in a diversified portfolio of institutional-level properties so it can pass income on to shareholders. Think of a REIT as a mutual fund for physical property, and you'll get the idea of just how simple this corporate structure makes it to own income-producing real estate.
Boring, but reliable
Investors like to see stocks that go up, making capital appreciation the big talking point for most people. But dividends account for roughly a third of the total return of the over the long term. No, dividends aren't exciting, but they do tend to be a highly reliable component of total return that gets overlooked. And since most real estate stocks pay sizable dividends, this is a core reason you might want to add some REITs to your diversified portfolio today.
It'll help to see some numbers here. The S&P 500 Index yields a scant 1.4% today while the average REIT, using the Vanguard Real Estate Index ETF as a proxy, yields 2.2%. But that's just an average; you can easily find REITs with higher than average yields and long histories of increasing their dividends annually. W.P. Carey (WPC -1.67%) is one such example, with a roughly 5.2% yield which it has hiked every year since its 1998 initial public offering (IPO). Meanwhile, Federal Realty (FRT -1.83%), yielding 4.4%, is the "King" of the REITs, with a string of increases that's over five decades long.
Play your cards right, and avoid double taxation
When you own a dividend-paying company, it pays taxes on its income and then pays you a dividend from what's left. REITs avoid that double taxation if they pay out at least 90% of their taxable income. The only taxes that get paid are by you, at your regular income tax rate. But you can avoid even that hit if you put a REIT in a Roth account (either a Roth IRA or a Roth 401k) which is funded with after-tax dollars. That means, if you play your cards right, you can create a stream of tax-free income. You can't do that with most dividend stocks, since they pay corporate taxes.
Options galore
While income-producing property seems like a singular thing, there are a lot of property sectors to choose from. For example, Prologis (PLD -1.93%) is one of the largest warehouse landlords in the world. AvalonBay (AVB -2.07%) is a huge apartment owner. And Realty Income (O -1.19%) is a big landlord in the retail sector. All are bellwether names in their respective niches.
But don't think you have to buy dozens of REITs, because there are some names that have highly diversified portfolios. W.P. Carey, noted above, has assets in the United States and Europe and spreads its portfolio across the industrial, warehouse, office, retail, and self-storage property niches. In fact, if you wanted to buy just one REIT, W.P. Carey is worth a close look.
An important diversion for volatile times
One last reason to like REITs is that the dividends they pay can help you sleep better at night. No investment can sidestep downturns, so REITs aren't some kind of panacea. However, if you were collecting the roughly 5% yield on offer from W.P. Carey in today's bear market, you could focus more on the income you collect rather than the paper losses in your portfolio. Every bull is followed by a bear and every bear by a bull; the hard part is staying invested through both the ups and the downs so you can benefit from the long-term growth of the companies you own. REIT dividends make that easier to accomplish.
Yes, please!
Owning real estate stocks like REITs won't turn you into Warren Buffett, but that's not really the goal you should be aiming for. What you want is a portfolio filled with good companies that you can stick with through good markets and bad ones. REITs will help you do that because of the dividends they pay, the diversification they offer, and the simplicity they provide to smaller investors. If you don't own REITs, you might want to start looking at the sector today.
Reuben Gregg Brewer has positions in Federal Realty Investment Trust, Realty Income, and W. P. Carey. The Motley Fool has positions in and recommends Prologis and Vanguard Real Estate ETF. The Motley Fool recommends AvalonBay Communities. The Motley Fool has a disclosure policy.
FAQs
Real estate investment trusts (REITs) are usually popular investments for income investors. They purchase a lot of properties, rent them out, and split the rental income with their investors. They also need to pay out at least 90% of their taxable earnings as dividends to maintain a favorable tax rate.
Why doesn t Warren Buffett invest in real estate? ›
Warren Buffett generally buys real estate only in the form of real estate investment trusts (REITs). He sticks to stocks because he thinks they offer a more efficient way to build wealth.
Does Motley Fool outperform the market? ›
Motley Fool Stock Advisor has a strong track record of stock recommendations with investment returns that have outperformed the broader market over the long term. Investors are still advised to diversify their portfolios with more than just Motley Fool Stock Advisor's picks.
Why are REITs a bad investment? ›
When investing only in REITs, individuals incur more risk than when they are part of a diversified portfolio. REITs can be sensitive to interest rates and may not be as tax-friendly as other investments.
Is Motley Fool respected? ›
The Motley Fool has long been a trusted name in the world of investment advice. Led by brothers David and Tom Gardner, the service helps average investors analyze Wall Street through stock-picking newsletters, specialized services, and educational resources.
Do billionaires invest in REITs? ›
Blackstone has been on a REIT buying spree. Its leaders are self-made billionaires, and they talk highly about REITs.
Is real estate a lousy investment? ›
That's why it's surprising that two of the most famous investors in the world — the late Charlie Munger and Warren Buffett — shied away from this industry. During a Berkshire Hathaway investor meeting in 2002, Munger said real estate tends to be a “very lousy investment” for companies like their own.
Do billionaires invest in real estate? ›
Ultra-wealthy individuals invest in such assets as private and commercial real estate, land, gold, and even artwork. Real estate continues to be a popular asset class in their portfolios to balance out the volatility of stocks.
Which reit does Warren Buffett own? ›
Buffet and REITs
However, Berkshire sold its holdings of STORE Capital in 2022 after the company announced it was being acquired by two outside investment funds. Since then, filings have shown that Berkshire Hathaway has not owned shares of any other REIT.
Is Motley Fool better than Morningstar? ›
If you want an exciting stock picking service that helps you build a portfolio of 10 or more stocks, The Motley Fool has you covered. Morningstar is the right choice for those who want a broader and more measured approach to picking their own investments.
The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon, Fiverr International, Home Depot, Meta Platforms, Nike, Nvidia, PayPal, Salesforce, Target, Uber Technologies, Visa, Walt Disney, and Zoom Video Communications.
What stocks does Motley Fool recommend? ›
What are the 10 best stocks to buy right now?
- PayPal (NASDAQ: PYPL)
- CrowdStrike (NASDAQ:CRWD)
- MercadoLibre (NASDAQ: MELI)
- Shopify (NYSE: SHOP)
- Airbnb (NASDAQ: ABNB)
- Intuitive Surgical (NASDAQ: ISRG)
REITs use a special structure to help with taxes
Unlike most corporations that pay income tax on profits and then investors pay tax again on dividends, most REITs avoid double taxation by paying out 100% of their taxable income to investors — who then pay ordinary income tax rates rather than lower capital gains rates.
Can REITs go broke? ›
REITs can offer a good way for retail investors to diversify their investment portfolios and access real estate markets without costly financial outlays or taking on the risk of owning property themselves. Cons: No investment is without risk, and REITs can and do go bankrupt – so it's important to do your own research.
Can you lose money in REITs? ›
Can You Lose Money on a REIT? As with any investment, there is always a risk of loss. Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds.
Should I invest in a REIT right now? ›
There are three key reasons to invest in listed REITs right now, starting with the fact that REITs have outperformed stocks and bonds when yields and growth move lower. Demand is healthy while supply is constrained, and REIT valuations relative to the broader equity market are meaningfully below the historical median.
What are the cons of buying REITs? ›
The potential downsides, or CONS, of a REIT investment include the fact that they are taxed as income, the variation in the fee structures of different managers, and market volatility due to interest rate movements or trends in the real estate market.
What is the average annual return on a REIT? ›
Over a 15-year period, according to Cohen & Steers, actively managed REIT investors realized an annualized 10.6% return. Of the other active strategies, opportunistic real estate funds placed second, at 9.8%. Core and value-added funds had average annualized returns of 6.5% and 5.6%, respectively, over 15 years.
How are REITs doing in 2024? ›
After lagging equities the past two years, REITs offer an attractive investment opportunity in 2024. The headwind of higher bond yields and central bank rate hikes is likely to abate and may turn into a tailwind if our view about an impending economic slowdown and decelerating inflation trends is correct.
