Real estate investment trusts, or REITs, invest in properties, allowing investors to enjoy the benefits of ownership without the associated headaches. This includes income in the form of dividends from REITs.
“REITs must pay at least 90% of their taxable income to shareholders,” says Chris Burbach, co-founder and partner of Phoenix-based Fundamental Income. “Dividends are generally paid on a quarterly basis and some are paid monthly.”
While it is tempting to receive a dividend, it is not the only reason to consider investing in a REIT. For example, it may be more accessible than direct ownership, as many of the best REIT funds have a low minimum to invest. REIT stocks can be bought and sold like stocks, making them relatively liquid investments.
Real estate can add diversification to a portfolio, helping to balance risk. In terms of total return, REITs can perform well.
According to a recent analysis by researchers in the Netherlands, real estate investments have exceeded inventories by one percentage point per year on average since 1960.
But there are a few things to keep in mind in order to earn REIT dividends in an investment portfolio:
- REIT Dividend Tax Rules.
- Dividends of REITs vs. Dividend Paying Stocks.
- How Dividends Compare by Type of REIT.
- How to invest in REITs for dividend income.
REIT Dividend Tax Rules
There are two sides to the tax coin with REITs: how the REIT itself is taxed and how investors are taxed on dividends and capital gains.
“REITs don’t pay taxes at the corporate level,” says Robert Johnson, professor of finance at Heider College of Business at Creighton University. “They are treated as intermediary entities like [limited liability corporations], partnerships and S. “
This is the biggest tax benefit of investing in REITs, Johnson says. “The income of a REIT is not subject to double taxation.”
So what does this mean for the REIT investor in simple terms? Simply that the REIT’s dividends are taxed as ordinary income for the final shareholder, no different from other stocks, says Ryan Giannotto, research director at New York-based GraniteShares.
This is important for investors who are focused on creating reliable income streams while maximizing tax efficiency.
REIT Dividends Versus Dividend Paying Shares
REITs aren’t the only investments that can pay dividends; many stocks offer regular dividend payments to investors. It’s important to understand how they differ, both from a tax standpoint and in terms of what drives the dividend payouts.
“With an ordinary share paying dividends, investors are subject to the phenomenon of double taxation, where profits are taxed at the company level and again at the individual level,” said Giannotto.
REITs are spared from a tax layer, which means they can offer relatively higher returns than a regular taxable corporation.
Burbach says that with stocks paying dividends, investors need to be tuned in to how the company is generating cash flow to pay the dividend. This usually comes from the sale of products or services. On the other hand, REITs use their contractual cash flows generated by leases to pay dividends.
“Investors can look at the length of these leases, how much cash flow is generated versus the dividend payment, and get a good idea of the security of the dividends paid,” he says.
With a dividend stock, the payouts are often tied to the overall stability and profitability of the business. If a business is having a difficult trajectory with income or is heavily in debt, it can affect the amount paid out to investors. The exception to the rule may be the Dividend Aristocrats, a group of companies that have consistently paid an increased dividend to investors year over year for 25 years or more.
Guy Baker, founder of Wealth Teams Alliance in Irvine, Calif., Says investors should be aware of factors that could also affect dividend payouts from REITs. He says two of the biggest are rising vacancy rates or property issues resulting from foreclosures or defaults.
“REIT dividends should be certain in a more predictable way,” he adds.
Comparison of dividends by type of REIT
Another consideration for real estate investors is how the type of REIT can dictate dividend payments.
“There is a myriad of REIT ecosystems that span the gamut of real estate business, from mortgage financing to direct real estate ownership, known as equity REIT,” said Giannotto. “REITs can specialize in different types of real estate, from commercial offices to residential apartments and houses, warehouses and even data centers and towers. “
Dividends paid by a REIT may be determined by the performance of the underlying assets of the REIT.
According to the National Association of Real Estate Investment Trusts, commonly known as Nareit, the dividend yield of all REITs was almost 4% in November 2019. Among equity REITs, the dividend yield was almost 3.6%. . In comparison, the return of the S&P 500 for the same period was 1.9%.
Experts differ in their estimation of the most reliable REITs when it comes to dividends. Baker loves mortgage REITs as a source of income.
“These REITs only lend money to owners and are number one in the event of borrower default,” he says. “Dividends can be considerably higher than normal REIT dividends.”
As 2020 approaches, Burbach says real estate investors should familiarize themselves with the real estate sectors that are poised to perform the best. He says that while office, industrial and apartment REITs are generally the most popular options, they don’t always produce the best returns.
The net lease industry, on the other hand, which focuses on properties leased to single tenants responsible for paying rent and property charges, often goes unnoticed but offers competitive returns.
How to invest in REITs for dividend income
Getting started with investing in REITs starts with researching various types of REITs. Comparing dividend payouts is a first step, but there are other things to consider.
Johnson says investors should consider the overall economic environment and how changes in monetary policy, such as rising or falling interest rates, might affect the performance of the REIT.
According to Johnson’s research, equity REITs earned 16.3% per year from 1972 to 2018 during periods of expansive monetary policy. When monetary policy became more restrictive, annual yields fell to 9.5% on average.
Investors should also understand the differences between a traditional REIT and a REIT fund. ETFs and mutual funds can provide exposure to a basket of REITs and their underlying assets, but it is important to avoid overlap to stay diversified.
Finally, weigh the risks of a specific REIT industry. Office buildings, for example, might be more sensitive to economic fluctuations because they tend to have shorter lease terms, Burbach says.
When investing in REITs for dividends or any other reason, remember the age-old rule of risk management: Know what you own.