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.
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 S&P 500 Index 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 (NYSE: WPC) 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 (NYSE: FRT), 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.
While income-producing property seems like a singular thing, there are a lot of property sectors to choose from. For example, Prologis (NYSE: PLD) is one of the largest warehouse landlords in the world. AvalonBay (NYSE: AVB) is a huge apartment owner. And Realty Income (NYSE: O) 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.
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.
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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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.