I am the “income man” here. I write a lot about dividend stocks and retirement planning. And if your focus is on income, real estate investment trusts (REITs) can be hard to avoid.
Of course I don’t want that!
Real estate has literally been the asset class of choice for wealthy investors for thousands of years, ever since mankind abandoned the nomadic lifestyle and settled in civilization. But real estate plays an important role in today’s financial world.
Most of us never own investment property. It is troublesome to manage. Few people want to call 3am about a broken toilet. Most millionaires will have a hard time building a diverse real estate portfolio given the cost.
Therefore, REITs are extremely valuable. It’s a diverse basket of publicly traded investment properties like Apple and Microsoft stocks. You can also keep it in an IRA or 401 (k) with ease.
REITs come in all shapes, sizes, and subsectors. You can invest in REITs that specialize in apartments, warehouses, and malls. You can also find more exotic ones that own data centers and cell towers. Think of every property you can think of. There is a REIT subsector for this.
That’s why I like to invest in REITs and believe that a bond portfolio would not be complete without REITs.
REITs are inflation hedges
For a long enough period of time, the value of all currencies will be zero … or at least close to it.
I hope the day will be decades or centuries ahead of the dollar. But even if the Federal Reserve’s inflation target is 2%, it will hit that point.
Inflation is like interest. It’s composed. Therefore, 2% per year is not “added up”. It’ll be a snowball guy.
An inflation of 2% in 20 years means that it will cost $ 1.49 in 2041 to buy $ 1 worth of goods and services today. Fifty years later, it costs $ 2.69 to buy something that costs $ 1 today.
It assumes the Fed will do something about it. Keep inflation at 2%. Or could break out like this. However, central banks don’t have the best track record in this regard.
In contrast to financial assets, which can be reproduced indefinitely, the amount of real estate is limited. That doesn’t mean real estate is always the best investment. It goes through the cycle like anything else. But as a long-term asset class, it is better than anything as an inflation hedge.
In most cases, rents rise with inflation, so the value of real estate should not only keep pace with inflation but also increase real estate income.
Do not make fun of it. The tax law is written by and for the rich, although it can mess up the exact marginal tax rate. It was always like that.
Of course I am not complaining. It’s not about good and bad. I just see it as an observable fact and I want to be a winning team.
It is already clear that the value of real estate will increase over time. According to tax law, however, depreciation is a depreciation.
Depreciation is a phantom expense, as money never comes out of your pocket. But it does have a real impact on your tax bill. The depreciation is often enough to offset a significant portion of your income.
REITs benefit as part of their dividends are often classified as tax-free “capital repatriation” rather than taxable dividends.
And it gets better. REITs also benefit from a special tax status that goes beyond that of a normal real estate investor. As long as the REIT pays at least 90% of its net income as dividends, no federal income tax is levied. And all the dollars saved on taxes.
And about that …
Invest in REITs for huge income
REITs are one of the highest-yielding stocks of all time. Tax cuts are one of them. Avoiding corporation tax removes one of the biggest costs for most businesses.
But here, too, leverage plays a role. I’m not a fan of companies that are in debt to squeeze their returns. Sure, it does increase earnings per share in the short term, but at the cost of more risk. Who can forget that after the 2008 collapse, Bank of America and General Electric had to go hand in hand to apply for a loan from Warren Buffett? This is what happens when management becomes a gentleman in debt.
But real estate is a different beast. Debt is often assigned to specific assets that have cash flows to support them. If you do it carefully, you can also generate income that can be distributed as dividends without adding significant risk.
Graduation: REITs are high-income, low-tax inflation hedges with liquidity in stocks. If you don’t invest in at least a few REITs in your income portfolio, you are wrong.
For safe use
Charles size more
Associate Editor, Green Zone Fortune
Charles Size More is Associate Editor of Green Zone Fortune, specializing in income and retirement issues. He is also a frequent guest on CNBC, Bloomberg and Fox Business.