Homebuilding stocks and exchange traded funds (ETFs) are in the doldrums as the housing market stagnates in record lows. High unemployment and even high lumber prices are pushing investors away from this area of the market. If the housing market were to turn around, several issues, such as the economy, interest rates and demand, would have to be completely in sync for a sustainable environment.
But not all real estate is cut from the same cloth. In fact, real estate investment trusts (REITs) might be an option to consider for your clients who are looking for income and some stability.
All About REITs
Even as the real estate market continues to get beat up and property values sink, REIT ETFs have pulled their weight in the markets over the last year, handily outperforming the S&P 500.
One way to explain this interesting phenomenon is that many REITs have boosted their balance sheets by raising money through secondary offerings and IPOs in 2009 and this year. REITs were also boosted with an upgrade from Fitch ratings from negative to stable. Industrial REITs were the only subsector to remain rated negative.
REITs are a way for investors to gain exposure to the housing and commercial real estate markets without actually having to own any property. REITs are holdings that accumulate money through initial public offerings, which is used to buy, develop, manage and sell assets in the real estate market.
Investor income is generated through renting, leasing and selling of the property and distributing the returns to REIT holders. This type of investment allows for a long-term outlook and potential income returns through rent and property appreciation. The industry paid out about $13.5 billion in dividends last year, according to NAREIT (the National Association of Real Estate Investment Trusts).
Pros and Cons
What happens to this income is where the big benefit to investors comes in: REITs are required to distribute almost 90% of their yearly taxable income to shareholders. This income deductible at the corporate level is taxed at the personal level – there is only one level of taxation for distributions.
However, the major downside to investing in a REIT also involves the dividend. That’s because the REIT has 10% of its profit to reinvest, which makes for slower growth. REITs are also touchy about interest rates, and prices have an inverse relationship to them. This may also account for their strong performance, since interest rates have been at record lows for more than a year.
By pooling the assets together, REITs also reduce risk and provides greater diversification since capital is distributed through numerous properties. If an individual were to mimic such a strategy, one would have to buy multiple properties, which is rather unlikely for the average retail investor. Investments in REITs are also a more efficient diversifier since REITs are more liquid as opposed to investments tied to physical property.
If you’re considering the addition of REITs to your clients’ portfolios, the ETF Analyzer has them all. From there, you can sort by performance, yield, assets and more.