4 Things to Know About Real Estate Investments
If you own your home, should you buy real estate securities? It’s a reasonable question because for many people, their home is a large portion of their overall wealth.
A family with $500,000 in savings, including stocks and bonds, and a home valued at $300,000 would seem to be heavily invested in real estate. But that’s probably not the best way to look at things – although your home may act as a store of wealth, history has shown it likely won’t do much better than keep up with inflation. It probably won’t beat the returns you’d get from the stock market.
Here’s why and how at least some real estate securities have a place in your investment portfolio.
You can diversity your portfolio. Returns on real estate investments have low correlations to other investments, such as the broader stock and bond markets, says Jay Jacobs, director of research at exchange-traded fund provider Global X in New York. When the Standard & Poor’s 500 index of large-capitalization stocks increases, you could see real estate stocks move up or down in price, or simply not move at all. That lack of correlation makes the value of an overall portfolio more stable over time. Given that investors view moves in value as a measure of risk, the lower the overall swings in a portfolio, the less risky it is considered.
It can provide great dividends. Your home might give you psychic dividends, but your real estate investments can pay handsome cash dividends. Take real estate investment trusts – they tend to pay high dividends, with the Vanguard REIT ETF (ticker: VNQ) yielding close to 4 percent. It owns a basket of 144 REITs and has low annual expenses of 0.12 percent, or $12 per $10,000 invested.
Real estate provides tax benefits. REITs are also advantageous from a tax perspective, Jacobs says. As long as the REIT distributes at least 90 percent of its income to stockholders, it pays no corporate tax. Instead, the investor pays the tax of the dividend as ordinary income. Most Americans are in a lower tax bracket than the statutory 35 percent corporate rate, so the only loser is the Internal Revenue Service.
Don’t overdo it. Jacobs says alternative investments, such as commodities, master limited partnerships and real estate should make up only 20 percent of an overall investment portfolio, with real estate being only a quarter of that. So overall, real estate investments should be no more than 5 percent of your portfolio, he says.
If you decide to buy individual REITs, you need to know that there are many different types, not just REITs for office buildings such as Brookfield Office Properties (BPO), says Jack Ablin, chief investment officer at BMO Private Bank in Chicago. Some invest in college dorms, such as American Campus Communities (ACC), which has a healthy 3.9 percent dividend. Another, Sun Communities (SUI), operates mobile home parks. There are other types, as well, for those inclined to look for specific exposure.
For most people, buying a fund might make better sense. Ablin says investors might want to consider the iShares Dow Jones U.S. Real Estate ETF (IYR), which holds a wide basket of 119 real estate securities, mainly REITs. It yields 3.7 percent and has expenses of $43 a year per $10,000 invested.
Outside of the REIT structure there are also homebuilder stocks, such as those held in the SPDR S&P Homebuilders ETF (XHB) and the home improvement retailers like Lowe’s Corp. (LOW) and Home Depot (HD.) Such stocks are closely linked to the fortunes of residential markets, which are also dependent on the availability of credit to finance purchases. It is also a volatile sector, as the XHB ETF has underperformed the broader markets over the last decade. (That period included the housing crash.)
Another advantage of buying securities is that it is possible to get exposure to foreign markets. “Globally, we are seeing the most attractive real estate opportunities in southern Europe – the economies have bottomed out,” says Brian Schmidt, head of U.S. real estate at the Minneapolis-based institutional investment firm Varde Partners.
While Varde is an institutional investor, the rest of us can look to funds that focus on specific geographies, such as the iShares Europe Developed Real Estate ETF (IFEU), which holds 97 stocks and annual expenses of $48 per $10,000 invested.
Simon Constable for Daily Finance | Lead image: Getty
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