I used to work in the real estate industry. I was a Realtor, with a focus on residential properties and property management. I got into that business because after handing over rent checks to landlords throughout college, I thought that I wanted to be on the other end of that transaction. In short, the pursuit of passive income has been at the forefront of my mind throughout most of my adult life. However, after several years, I decided that I prefer the Real Estate Investment Trust – REIT – path, as opposed to the path of the landlord…and in this article, I’ll explain why.
It’s been several years since I transitioned away from the real estate business and into the portfolio management business, full-time. But, even so, I know that home prices are booming. You don’t need to be a Realtor to know that. Just about every day, I’m reading headlines about the strength of the housing market across a variety of media outlets.
I don’t know about you, but I love checking the “Zestimate” of my house as shown by Zillow. According to Zillow, just during the last couple of years alone (since the start of 2020) the value of my home has increased by more than 30%.
I’ve strongly considered taking advantage of this appreciation; however, the fact of the matter is, if I want to stay local, it doesn’t make sense to sell, pay commission, and move into another neighborhood in our desired school district because all of the other homes are very pricey as well.
My grandmother just sold her home. She decided to relocate into an assisted living facility after a rough holiday season and we listed her house in early April to take advantage of the hot spring buying season. That house sold for nearly 60% more than she paid for it just a couple of years ago.
This was great news. The sale should secure her finances and allow her to rest easily at her new facility. But, as amazed as I was with the profits that she was able to lock in over a relatively short period of time, she wasn’t surprised.
Speaking to her about this success and it didn’t surprise her. She told me the story of all of the homes that her and my grandfather lived in throughout their lives. There were 5 in total and they made great profits on every single one. My grandparents weren’t home flippers. They were a fairly normal, hard working american family who prioritized living below their means and investing in hard assets.
I say all of this to make it clear that while I don’t have plans to build an empire of rental properties anymore, I do believe in importance of home ownership as a part of the journey towards financial freedom and the potential for hard assets to preserve – and even grow – wealth throughout a wide variety of economic conditions.
This is especially the case during inflationary times like we’re living in today. I couldn’t be more thankful that my wife and I decided to buy our first home 7 years ago. It feels great building equity with mortgage payments as opposed to writing checks to someone else and allowing them to build theirs. But, even though Zillow continues to expect home prices to climb (the company’s most recent macro report points towards the average home price in the United States rising by another 17% over the next year or so), I’m fairly content to own only one home.
Why is that?
Well, because I can gain relatively stress free exposure to the real estate market via REITs.
There are several reasons why I prefer to own REITs as opposed to rental properties…
Generally speaking, in the rental property game, landlords want to collect approximately 1% of the home’s overall value per month. This implies a ~12% annual return. That sounds pretty great, right? Who wouldn’t want to compound their wealth at a reliable ~12% clip? Well, even with that in mind, let me explain why I still prefer REITs.
It’s also important to note that this expectation is for gross income before things like maintenance, insurance, and taxes are deducted.
Anyone who has owned property knows that there are constant upkeep costs involved. Furthermore, not only do these repairs cost money, but they take up time and cause a lot of stress for someone like me who isn’t a handyman. Avoiding this hassle is enough of a reason for me to own REITs (where professional management teams take care of maintenance issues for me). However, it’s not the only reason why I prefer equity exposure to real estate as opposed to owning physical properties outright.
These double digit annual return prospects that landlords lean into also assume that the property maintains a 100% occupancy ratio.
In many areas, there is a high likelihood that this is the case. In the college town where I live, properties with close proximity to the University are in high demand. Therefore, I wasn’t overly concerned with occupancy issues; however, the fact of the matter is, I’ve read far too many stories about nightmare tenants that involved the local sheriff and a court of law to believe that rent checks are risk-free and guaranteed.
Once again, by owning REITs, I don’t have to worry about marketing my properties, paying a property manager to make sure that it stays rented, and in the worst case scenarios, fighting legal battles with unruly tenants or outright squatters. With REITs, I allow a powerful team of real estate professionals with marketing and legal teams to worry about these potential issues for me.
Finally, while I admit that physical property is an attractive asset class to have exposure to within the overall confines of an individual’s financial situation, the relatively high price of homes, combined with their relatively illiquid nature, means that investing in a single rental property would tie up a relatively large percentage of my capital, reducing my overall diversification and representing a very high single asset risk .
Honestly, in today’s housing market, that might not be a problem. Houses where I live are selling above asking within a matter of days. But generally speaking, it takes time and money to flip houses and that’s not something that I’m interested in.
On the other hand, the medium and large cap blue chip REITs that I focus on maintain very high degrees of liquidity. While I’m not someone who likes to make short-term trades in the market, it wouldn’t be difficult for me to do so in the REIT space. Furthermore, in today’s age where there are no commission costs associated with equity trades at most major brokerages, trading REITs is free (which isn’t the case in the real estate space).
By owning REITs, I’m able to buy a small piece of a very large basket of high quality assets. And historically speaking, blue chip REITs have generated very attractive returns for shareholders, meaning that I’m not necessarily sacrificing gains when prioritizing simplicity and lower stress levels with REITs.
For instance, my favorite REIT in the residential space, Essex Property Trust (ESS), which specializes on West Coast multi-family (apartment) complexes, has generated 16.2% compounded annual returns for investors dating back to its IPO in 1994.
AvalonBay Communities (AVB), another blue chip multi-family REIT, which offers investors a more diversified portfolio (in terms of the geographic locations of its properties) has generated a 13.4% compounded annual returns since its IPO in 1994.
And, if you’re not interested in owning apartment buildings, but instead, commercial buildings, like convenience stores, drug stores, dollar stores, big-box stores, restaurants, and even industrial buildings, like warehouses in the logistics space…well, Realty Income (O) is another blue chip REIT that has generated double digit CAGRs for investors over the long-term.
O owns more than 11,000 commercial properties and since its IPO in 1994, the company has generated compounded annual returns of approximately 15.5%.
Realty Income is a triple net lease REIT, which means that it passes along the costs associated with taxes, insurance, and maintenance to its tenants (alongside contractual rent escalators built into its long-term contract agreements).
The triple net lease structure is a landlord’s dream. Companies in that space generate some of the highest margins in the overall stock market. And, with that in mind, there’s no wonder that the talented leadership at Realty Income has been able to generate such strong and reliable fundamental and dividend growth over the years.
But, the allure – to me, anyway – of the investment property space isn’t capital gains, but instead, reliably increasing passive income.
Landlords generate this with contractual rent increases…and REITs do the very same thing.
No, none of the blue chip REITs that I just mentioned offer a double digit dividend yield (akin to the ~1% monthly rent checks that landlords aim to receive); however, the dividends that they pay are quite safe and reliable, which, once again, offers an attractive proposition to someone like me who prioritizes simplicity, reliability, and low-stress over maximized return potential.
For instance, ESS is on a 27-year annual increase streak. AVB is on a 10-year annual increase streak (after freezing its dividend growth during the Great Recession); however, since its IPO, AVB has generated ~5% annualized dividend growth. And, Realty Income, which has trademarked the phrase, “The Monthly Dividend Company” has paid 621 consecutive monthly dividends, is on a 29-year annual dividend increase streak, and has compounded its dividend payments at a 4.4% annual clip since its 1994 IPO.
The fact that I can generate reliably increasing passive income while also benefiting from economies of scale and the low cost of capital that these massive entities can take advantage of makes investing in REITs an appealing opportunity to me.
These are just a few of the REITs that we cover at Wide Moat Research via The Intelligent REIT Investor and the Intelligent Dividend Investor newsletters…so, if you’re someone like me who is interested in the real estate market and the reliable passive income that it can generate, but doesn’t feel comfortable investing in physical properties becoming a landlord, please stop by and check out of Real Estate sector coverage so that you can consider diversifying your holdings as well.
This article is intended to provide information to interested parties. As we have no knowledge of individual circumstances, goals and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. It does not guarantee that securities mentioned in this newsletter will produce profits or that they will equal past performance. Additionally, we are not an investment advisor and do not offer securities or tax advice. Although all content is derived from data believed to be reliable, accuracy cannot be guaranteed. Nicholas Ward, contributors and staff members of Wide Moat Research may hold positions in some or all of the stocks listed.
Disclosure: Of the stocks discussed in this article, Nicholas Ward is long ESS, AVB, and O.
Nicholas Ward is a research analyst who currently writes for Seeking Alpha, The Dividend Kings, iREIT, and Forbes Real Estate Investor. Before that, he was Founder and Editor-in-Chief of The Dividend Growth Club, as well as the Income Minded Millennial. Nicholas has also contributed to Sure Dividend, Investing Daily, and The Street, where he covered stocks in Jim Cramer's Action Alerts PLUS Portfolio.
Nicholas holds a bachelor of arts from The University of Virginia, where he studied English and studio art. Prior to transitioning into the financial industry, he managed a vineyard in the foothills of the Blue Ridge Mountains.
