A Real Estate Investment Trust (REIT) is defined as a number of real estate companies that own a portfolio of income-producing real estate assets. Because of their business model, investing in a REIT allows investors to earn a share of the income that these assets produce. This happens in the form of a dividend. And because of federal regulation regarding REITs, these companies tend to pay out a higher dividend (in terms of dividend yield) than other dividend stocks.
In this article, we’re going to explain the benefits of high dividend REITs for investors. This includes the dividend income that helps boost their total return. We’ll also explain why they are an ideal option for investors who are looking to invest in different asset classes.
What is Diversification?
When talking about the stock market, diversification is more than owning a basket of stocks, even if those stocks are part of a mutual fund or exchange-traded fund (ETF). Diversification is about owning multiple asset classes.
The “traditional” portfolio that many investors hear about is the 60/40 portfolio. This means investors should have a portfolio with an allocation of 60% towards stocks and 40% towards bonds. But today, investors also understand the importance of having exposure to other asset classes that include commodities (e.g. precious metals), real estate, and, for the most risk-tolerant investor there are cryptocurrencies.
Diversification also means diversification within asset classes. Having money in eight ETFs will not provide diversification if all the ETFs invest in essentially the same companies.
The Role of REITs in Diversification
Investing in real estate is a reliable way to build wealth. But the vast majority of individual investors don’t have access to the capital to buy real estate. And if they plan to use their real estate holdings as rental properties, they will require some additional capital.
By investing in a REIT investors are not investing in physical real estate. Rather they are investing in companies that own real estate properties. Instead of collecting rent or interest from their properties, REIT investors get paid via a dividend.
And this dividend is, in fact, a guarantee. The rules that govern REITs mean that the company must payout a high percentage of their profits (usually at least 90%) as a dividend. That’s one reason why financial advisors recommend REITs to their income-oriented clients.
Although the obstacles to holding physical gold and silver are not as cost-prohibitive as that of owning real estate, a good way of thinking about REITs is the difference between owning physical gold and silver or investing in mining stocks. Both give investors the opportunity to invest in a specific asset class that helps provide real diversification.
REITS are a Hedge Against Inflation
A second benefit to owning high dividend REITs is a hedge against inflation. These stocks will tend to underperform the market in terms of capital gains. But the dividend will help to make up the difference in terms of total return.
A 2020 study by JPMorgan Chase showed that in the 20-year period from 2001-2020, the S&P 500 Index provided an average return of 7.5%. On the other hand, REITs provided an average return of 10%. Of course, there has to be some nuance applied to this statistic. Some S&P 500 outperformed the average and some REITs underperformed their average. But in general, this shows that investing in REITs has the potential to boost an investor’s total return.
That’s particularly significant in times of high inflation. For most of those 20 years, investors were not concerned with inflation that was higher than the Federal Reserve’s target rate of 2%. However, in 2022, inflation rose significantly beyond the Fed’s preferred rate. And that makes a guaranteed high yield dividend an attractive option for investors.
How to Invest in High Dividend REITs
Investors can choose from a range of companies. In fact, MarketBeat provides subscribers with access to a frequently updated list of REITs that pay a high dividend. However, many individual investors don’t have the time or the inclination to pick their own stocks, particularly for an asset class that may make up only a small part of their portfolios.
An alternative is to invest in REIT ETFs. Investors may not capture the very highest dividend yield available. But leaving a few chips on the table is the trade-off with any ETF. What investors get is a smoothing effect with the peace of mind of an investment that historically tends to provide a Goldilocks (not too high, not too low) level of performance.
There are over 200 REIT ETFs for investors to choose from. Many of these are becoming part of a 401(k) plan. But as with any investment, investors need to perform their own due diligence. Some things for investors to consider include:
What is the investment philosophy of the fund? A fund that is concentrated on specific niches of REITs may cause investors to take on too little or too much risk than is needed to match their investment goals.
Is the fund actively or passively managed? In an actively managed ETF, a dedicated portfolio manager buys and sells the REIT stocks that make up the composition of the fund. In a passively managed ETF, the portfolio manager will seek to buy stocks that track closely with an index fund. For REITs one of the more closely followed indexes is the Financial Times Stock Exchange (FTSE) Nareit Index tracks the performance of the U.S. REIT Industry and the Global REIT market.
