By: Yale Bock, President & Founder, Y H & C Investments
There are two categories of investment many are familiar with: capital gain and income. Capital appreciation is simply buying a security at a lower price and selling it at a higher one. Income is money you receive from owning a security, whether interest or dividends paid out by a company. From a stock ownership perspective, capital appreciation is the holy grail as 3, 5, 10, 20, 50, or 100 times your original outlay is the definition of wealth creation. It is often difficult, and in many cases near impossible to come by. One or two ten or twenty baggers in an investment career can be all one needs. You really shouldn’t count on them taking place. If we turn to income, it should be a much more reliable area of investment because you should be able to depend on money coming in at regular intervals. The Real Estate Investment Trust (REIT) category is an area that is excellent for income-generating equities. The income streams are backed by diverse types of real estate ownership. REIT companies are mandated by law to pay out at least 90% of their taxable income as dividends. You must be careful as the key term here is taxable income. The crucial questions to consider when evaluating a REIT are what are the assets they own, how much cash flow the assets produce, and why do I want to own these assets for the long term?
One way to approach the question is by looking at replacement costs. How much did the assets cost the company? How and when were they obtained? Can they easily be replaced and what would the current market value of the assets be today? By doing your homework, you learn what it is you will end up owning. The fundamental issue revolves around the durability of the income which real estate generates. REIT investing has a risk because sometimes the underlying assets are not as solid as previously thought, and circumstances can change quickly. You want certainty, so look for a long track record of dividend payouts, low payout ratios, and decades of slowly increasing dividends. In my opinion, good areas to consider are farmland, warehouses and distribution centers, energy storage, grocery-anchored shopping malls, cell phone towers, hospital-based real estate, and government facilities. Owning credit-based REITs may also be a suitable alternative depending on your specific circumstances.
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Investing involves risk, including the possible loss of principal. Diversification does not ensure a profit nor guarantee against a loss.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information is not intended to be individual or personalized investment or tax advice and should not be used for trading purposes. Please consult a financial advisor or tax professional for more information regarding your investment and/or tax situation.
Investing in REITs exposes investors to the risks of owning real estate directly, as well as to risks that relate specifically to the way in which real estate companies are organized and operated. Generally, real estate is very sensitive to general and local economic conditions and developments and subject to intense competition and periodic overbuilding. Many real estate companies, including REITs, utilize leverage, increasing risk and adversely affecting their operations and market value in periods of rising interest rates. The use of leverage could exacerbate related investment losses. REITs are affected by changes in the values of underlying properties they own or operate, are dependent upon specialized management skills, and their investments could be concentrated in relatively few properties, a small geographic area or a single property type. REITs are also subject to heavy cash flow dependency and are reliant on the proper functioning of capital markets. If a lessee defaults, the REIT may experience delays in enforcing its lessor rights and may incur substantial costs to protect its investments. REIT investors should consult with their accountant or tax attorney on the tax consequences of investing in these instruments, as dividend payments made out by REITs could be taxed as ordinary income at the top marginal tax rate.
YH & C Investments may have positions in the types of companies mentioned in this piece. It is the responsibility of each investor to research the investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives.