This guest contribution is by Ben Reynolds and Samuel Smith of Sure Dividend. You may remember Ben from his previous guest posts – How I Became A Successful Dividend Growth Investor and Reaching Early Retirement Through Dividend Growth Investing. REITs are a frequent topic among Making Sense of Cents readers, so I’m pleased the experts at Sure Dividend are covering this subject today. Enjoy!
Ben Reynolds of Sure Dividend here. Sure Dividend helps individual investors build high-quality dividend growth portfolios.
I want to introduce Making Sense of Cents readers to a practical, diversified way to invest in real estate: Real Estate Investment Trusts (REITs).
We began focusing on REITs at Sure Dividend in 2016 because they offer distinct features that make them attractive for investors seeking current income and long-term income growth.
Our readers were curious about REITs, so we researched them thoroughly.
I learned that REITs are required by law to distribute at least 90% of their taxable income to shareholders as dividends.
That requirement means REITs return the majority of their earnings directly to investors.
I also learned that REITs have specific tax advantages that make them efficient vehicles for passing income to shareholders.
Finally, I discovered that investing in publicly traded REITs makes real estate exposure simpler and more diversified compared with owning individual properties.
These qualities convinced us that REITs deserve focused coverage because of the benefits they provide income-oriented investors. Keep reading to learn more about this distinct investment category.
The term “Real Estate Investment Trust” originated in the United States Congress in 1960 and has since become a global descriptor for a tax-advantaged vehicle designed for collective real estate investment.
We maintain a list of publicly traded REITs, including key financial metrics such as dividend yields and market capitalization.
Like mutual funds that pool investor capital to buy diversified holdings, REITs let investors own a share of a diversified real estate portfolio without the responsibility of buying, managing, or financing properties directly.
Most REITs are publicly traded on stock exchanges, enabling investors to participate in large, professionally managed real estate portfolios in the same way they invest in other sectors.
REITs are structured as corporations but are exempt from corporate income tax if they comply with specific rules. According to NAREIT, a REIT must:
- Invest at least 75% of its total assets in real estate.
- Derive at least 75% of its gross income from rents, mortgage interest, or real estate sales.
- Each year, distribute at least 90% of its taxable income to shareholders as dividends.
- Have a board of directors or trustees.
- Be owned by at least 100 shareholders.
- Ensure that no more than 50% of its shares are owned by fewer than six individuals.
These rules protect shareholders, promote disciplined capital allocation, and reduce conflicts of interest between managers and investors.
Why invest in REITs?
Historically, REITs have delivered strong returns—on average around 15% annually—and have outperformed many other asset classes over long periods.
REITs have been particularly rewarding for early, knowledgeable investors. Beyond strong total returns, REITs typically offer higher dividend yields, lower volatility relative to some equities, inflation protection, and diversification benefits.
Many wealthy individuals credit real estate for a significant portion of their net worth; REITs provide a way to gain real estate exposure while benefiting from professional management, diversification, liquidity, lower transaction costs, and passive income.
How to invest in REITs
Direct real estate investing can be expensive and time-consuming. You deal with brokers, contractors, lenders, tenants, and property managers. From due diligence to closing, transactions can take months and transaction costs often range from 5–10% of the purchase price.
REITs simplify, speed up, and reduce the cost of gaining real estate exposure. With a brokerage account, you can buy shares of publicly traded REITs in a few clicks, just like any other stock. Fees are usually minimal or zero, and trades settle quickly.
How much REIT exposure is right for you?
While REITs are attractive long-term investments, it’s important to remain diversified and avoid concentrating too much in a single asset class.
The appropriate allocation depends on your return goals, risk tolerance, and comfort with real estate exposure.
There’s no universal answer, but a diversified portfolio that includes a meaningful REIT allocation can reduce volatility and enhance long-term returns.
David Swensen, the former manager of the Yale endowment, recommended roughly 20% allocation to real estate. Institutional and financial advisors often suggest 15–30% exposure to real estate, which is a reasonable guideline for many investors.
Ultimately, choose an allocation that aligns with your objectives and comfort level.
How to pick quality REITs
Selecting REITs should reflect your investment goals and risk tolerance. In general, an attractive REIT will exhibit several of the following traits:
- A differentiated strategy that creates and preserves value.
- Resilient and stable cash flow generation.
- A strong balance sheet and growth pipeline to expand assets through cycles.
- A superior dividend yield that is well-covered across market cycles.
- A valuation below historical norms, offering a margin of safety.
If a REIT possesses many of these characteristics, it has a good chance of performing well over the long term. However, rare companies that meet all criteria often trade at premium valuations.
No selection method is infallible, but applying consistent filters helps minimize the risk of poor investments while improving the odds of identifying winners.
We use four core filters:
- Management alignment: Is governance, executive compensation, and insider ownership aligned with shareholders? Internally managed REITs with significant insider ownership and performance-linked compensation tend to outperform those without these features.
- Asset quality: Are the properties high quality or challenged? In weaker sectors, emphasizing quality is crucial. Metrics like same-store NOI, leasing spreads, and occupancy help assess asset quality.
- Balance sheet strength: Does the REIT maintain a healthy balance sheet? Check credit ratings, debt-to-asset ratios, fixed-cost coverage, and debt-to-EBITDA relative to peers.
- Valuation: Does the REIT trade at an attractive price? If the first three filters are strong, you may accept a smaller discount, but generally seek REITs trading below historical price-to-FFO or price-to-NAV.
Putting it all together
REITs can be powerful tools for long-term wealth accumulation and passive income generation. That said, REITs vary widely in quality and risk.
For experienced, active investors, selecting individual REITs can be a rewarding way to gain real estate exposure. For investors who prefer a passive approach or lack confidence in selecting individual REITs, diversified REIT ETFs—such as broad market REIT funds—offer convenience and instant diversification.
Are you interested in learning how to start investing in REITs?