In­vestors should con­sider REITs

Home - Santa Fe Real Estate Guide - - INVESTING - SAM DELUCA

Real es­tate in­vest­ment trusts (REITs) should be con­sid­ered when con­struct­ing a port­fo­lio. A REIT pro­vides greater di­ver­si­fi­ca­tion, po­ten­tially higher to­tal re­turns and/or lower over­all risk. In short, its abil­ity to gen­er­ate in­come along with cap­i­tal ap­pre­ci­a­tion makes it an ex­cel­lent coun­ter­bal­ance to stocks, and cash. A REIT can be a prof­itable way to es­tab­lish en­hanced re­turns but re­quires le­gal tal­ent to en­sure that it is the best op­tion.

The cor­re­la­tion of the S&P 500 with REIT in­dexes is very low so the cash gen­er­ated by a REIT con­tin­ues even in a stalled econ­omy. Bonds are the nor­mal al­ter­na­tive to stocks, but there is room for us­ing a REIT as well. Large buy­ers of REITs are ex­change traded funds, pen­sion funds, en­dow­ments, foun­da­tions, in­sur­ance com­pa­nies, and bank trust de­part­ments.

Not all the var­i­ous types of REITs can be dis­cussed in this ar­ti­cle, so the ba­sic rental-prop­erty REIT will be out­lined. A few types of th­ese funds are res­i­den­tial, apart­ment, busi­ness of­fice, health care, and farm­land. In­vest­ing in ba­sic rental prop­er­ties This is a very old prac­tice of own­ing prop­erty and leas­ing it out. A per­son will buy a prop­erty and rent it out to a ten­ant. The owner/ land­lord is re­spon­si­ble for pay­ing the mort­gage, taxes and costs of main­tain­ing the prop­erty. Ide­ally, the land­lord charges enough rent to cover all of the afore­men­tioned costs and may also charge more in or­der to pro­duce a monthly profit, but the tra­di­tional strat­egy is to be pa­tient and only charge enough rent to cover ex­penses un­til the mort­gage has been paid, at which time the ma­jor­ity of the rent be­comes profit. Fur­ther­more, the prop­erty may also have ap­pre­ci­ated in value over the course of the mort­gage, leav­ing the land­lord with a more valu­able as­set. Ac­cord­ing to the U.S. Cen­sus Bureau, real es­tate has con­sis­tently in­creased in value from 1940 to 2006, then pro­ceeded to dip and re­bound from 2008 to 2010. Be­side the his­toric uses of REITs, new REIT’s are com­ing on board, in­volv­ing tim­ber, casi­nos, stor­age fa­cil­i­ties, cell tow­ers, and even bill­boards.

The down side of REIT’s is com­pe­ti­tion. For ex­am­ple, an of­fice-com­plex REIT in a lo­ca­tion with other of­fice com­plexes can cause too much com­pe­ti­tion and cause rents to be pres­sured down­ward and pos­si­bly even cause the bor­rower to de­fault.

The most im­por­tant mat­ter is find­ing the right prop­erty in the right lo­ca­tion. You want to pick an area where va­cancy rates are low and­where peo­ple will­want to rent. I per­son­ally fa­vor REITs that are in smaller towns and ful­fil the needs of the par­tic­u­lar town, for in­stance an of­fice REIT that will at­tract ten­ants with the right ameni­ties— es­pe­cially all the high­tech fea­tures needed in a mod­ern busi­ness — and will be per­ceived as a high-end of­fice fa­cil­ity. That’s just one ap­proach; there are many-many oth­ers.

The prop­erty REIT holder’s motto is “LO­CA­TION, LO­CA­TION, LO­CA­TION.”

The REIT that has been ag­gres­sively ad­ver­tised lately is for “se­nior liv­ing fa­cil­i­ties.” I may be wrong, but I have a prob­lem with the very high “promised” re­turns. First of all, we baby boomers will not be en­ter­ing into retirement homes for years. Plus we are health­ier than our par- ents and are ex­pected to live longer. The rates of ex­pected re­turns are not prom­ises. The ar­ti­cles of in­cor­po­ra­tion guide their ac­tion and one sec­tion con­cerns re­turn on in­vest­ment. Read the fine print be­fore buy­ing.

SamDeLuca is a reg­is­tered in­vest­ment ad­vi­sor. As an RIA he le­gally rep­re­sents his clients as at­tor­neys and CPAs do. He has been a cer­ti­fied financial plan­ner for 17 years. His spe­cialty is help­ing peo­ple to in­vest for retirement. Prior to be­ing an in­vest­ment ad­vi­sor, he worked for a CPA firm.

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