DISCLOSURE: THIS POST MAY CONTAIN AFFILIATE LINKS,MEANING That I GET A COMMISSION IF YOU DECIDE TO MAKE A PURCHASE THROUGH MY LINKS, AT NO COST TO YOU. PLEASE READ FULL DISCLOSURE HERE
So, how do you invest in REITs? If you are investing in REITs, what are the best REITs to buy?
This is part (II) of the REITs investing series.
Previously, I talk about whether or not REITs are a good investment.
If you missed part (I) of the REITs investing series, you can read it here.
Today, we will go through all the details on how you can get started investing in REITs and also what REITs you should buy to maximize your returns and minimize your risk.
The BIGGEST Mistake To Avoid While Investing In REITs
Just like any other type of investing (e.g. stock investing or ETF investing), you must avoid making one of the most costly mistakes – never make an investment plan before you get started.
Here is why.
First of all, ANYTHING can happen in the market.
With a well-thought plan, you won’t be left wondering what to do when something unexpected happens.
Let’s say that the price of the REITs that you bought has gone down by 30% or even more.
What are you going to do?
Are you going to hold and maybe buy more shares to average down your cost per share?
Or are you going to sell and cut your loss?
On the other hand, what if the price has gone up by 30% or even more?
Are you going to take all or part of your profits?
Or are you going to hold onto your position and keep getting dividends?
When you have a plan, you avoid letting your emotions get in the way of making investment decisions.
Secondly, you can CONTROL your risk through investment planning.
As you already know, investing comes with risk.
But, it’s a good thing that you can limit your risk by mapping out an investment plan for all different possible scenarios (the best and worst scenarios).
Now, what do I mean by that?
Here’s a hypothetical example.
Let’s assume that you have invested $10,000 in REITs XYZ at $1 per share for 10,000 shares.
If you set your maximum loss for your investment at $2,000, then you would liquidate your positions when your unrealized loss hits $2,000.
That’s how you control your risk beforehand.
How To Make Your REITs Investment Plan
So, how do you make an investment plan?
It’s actually very simple.
There are five things that you must include in your REITs investment plan:
- What are your investment goals
- How much to invest in REITs
- What REITs to buy
- When to buy & How much you buy and at what price you buy
- When to sell & How much you sell and at what price you sell
What Are Your Investment Goals
Before you make your investment plan, you must be clear about your investment goals.
Do you want to invest in REITs for the long term for retirement income?
Or do you just want to buy REITs to beat inflation and grow your wealth?
Or do you just want to make some quick money in the short term?
First of all, if you want to make some quick money in the short term, then that is NOT investing.
That’s called speculative trading.
And, if you are looking for trading tips, that’s not what this blog post is about.
Personally, I am investing in REITs for retirement income.
That means, instead of spending all the dividend income I get from my REITs investments, I will re-invest it and take advantage of the power of compounding to grow my investment portfolio.
Below is a chart that shows you the difference in returns between reinvesting dividends and not reinvesting.
By simply re-investing the dividends every year, the total return is about more than 5 times higher.
Regardless of whether you want to just grow your wealth or you want to invest for future retirement income, you should always be reinvesting dividends to maximize your returns.
How Much To Invest In REITs
So, how much do you want to invest in REITs?
Are you going to have a REIT-only investment portfolio?
Or are you going to invest a part of your total savings in REITs?
First of all, I don’t recommend a REIT-only investment portfolio.
It’s too much concentration risk.
Over the past decade, we have been in a low-interest rate environment which has benefited REITs a lot and almost all REITs have been in an uptrend.
But, do we know for sure that low-interest rate is going to stay here forever?
If it’s not, your REITs-only portfolio will probably go down in value when that changes.
Also, as REITs derive almost all their revenue from rental income, their performance can easily get affected by the economy.
If the economy does not improve for a prolonged period, REITs are going to suffer even more.
This is because they probably won’t have enough cash on hand to help them weather a long period of an economic downturn after paying out 70% to 90% of their net income as dividends every year.
So, are you mentally prepared to deal with a large drawdown in your portfolio when it happens?
Also, if you invest all your money in REITs, you can expect a lot more volatility in your portfolio compared to a more diversified one.
Now, back to the question, how much should you invest in REITs?
Here’s what I recommend.
You should always allocate less than 50% of your total portfolio to REITs.
Depending on your risk appetite and your financial goals, you can adjust the percentage to suit your own situation.
Let’s say you are nearing retirement and your goal is a stable income after retirement.
So, a conservative yet suitable asset allocation might look something like this:
- Investment-Grade Bonds: 50%
- Dividend Stocks: 25%
- REITs: 25%
What REITs To Buy
Now, you have made your investment plans for REITs.
What REITs are the best REITs to buy?
Highest yield REITs?
When it comes to the best REITs to buy, you must always choose your REITs investments from a portfolio perspective.
So, what do I mean by that?
It’s very risky to just put your money in a single REIT or in any one type of REIT.
First of all, the performance of any REIT depends on a number of factors (that are really out of your control) such as:
- Economic conditions
- Interest rate changes
- Industry-specific changes (i.e. Healthcare REITs can be adversely affected by any policy change in Medicare. Hospitality REITs can be negatively affected by any disease outbreak)
- Competence of the REIT manager ( i.e. If they do a poor job, then your investments will suffer as a result)
But, what you can do is do everything you can to minimize your investment risk.
How do you do that?
First, you should diversify your REIT investments across a number of REITs from different industries.
Below is the price chart of retail REITs called ” Simon Property Group” and that of healthcare REITs called” National Health Investors”.
As you can see from the above, retail REITs performed much worse than healthcare REITs in recent years.
Here are some possible reasons for the recent downtrend in retail REITs:
- Some major tenants of shopping malls are closing down (Industry-specific factor)
- E-commerce rising in popularity and threatening retail sales (Industry-specific factor)
- The coronavirus outbreak leads to a sharp decline in consumers spending in malls (A non-recurring factor)
On the other hand, healthcare REITs are very resilient and defensive even when the economy is not good.
So, should we just put all our money into healthcare REITs?
The answer is No.
Although it’s a very defensive REIT, it has its own unique weaknesses.
One of them is that they are very sensitive to government policy changes in healthcare.
If the policy change is unfavorable, it is going to affect its performance negatively.
That’s why no REITs are perfect.
But, you can limit your risk by diversifying your REITs portfolio.
Just like how bonds balance your stock investments, defensive REITs such as healthcare REITs can complement retail REITs which are very dependent on the state of the economy.
So, when you choose what REITs to buy, you must take into account how they can complement each other to reduce your overall risk.
Here are the different types of REITs:
- Retail REITs (Cyclical)
- Commercial REITs (Cyclical)
- Industrial REITs (Cyclical)
- Hospitality REITs (Cyclical)
- Healthcare REITs (Defensive)
- Infrastructure REITs (Defensive)
- Data Centres REITs (Defensive)
Once you have decided what type of REITs you want to include in your REITs portfolio, the next step is to choose which specific REITs you want to buy.
And we have covered this in great detail in part (1) of the REITs series. If you missed it, you can read it here.
If you don’t want the trouble of having to research each individual REIT, the best alternative is to just buy REITs ETFs which is an exchange-traded-fund that holds different REITs and tracks the performance of a particular REITs index.
For example, Vanguard Real Estate ETF is quite a good choice.
It also has one of the lowest fees among all the ETFs. (this is very important for ETF investing as even a small increase in fees can reduce your returns significantly over time)
From the screenshot below, you can see that it’s a very diversified REIT portfolio.
- How do you want to allocate your funds to each of them
- When do you want to buy and how much do you want to buy at what price
- When do you want to sell and how much do you want to sell at what price
For example, let’s say you have decided that you want to build a $500,000 investment portfolio with 50% in bonds, 25% in stocks, and 25% in REITs.
So, you have a total of $125,000 allocated to REITs.
If you are going to invest equally in 4 REITs (one healthcare REIT, one infrastructure REIT, one industrial REIT, and one retail REIT), then that means you can buy $31,250 worth of each REIT.
Of course, you can adjust your percentage allocation to suit your own investment objectives.
For example, if you want to be more conservative and go overweight defensive REITs, you can allocate more money to them.
Now that you know how much to invest in REITs, the next step is to plan how you are actually going to buy them (i.e. how many units are you going to buy at what price)
Are you going to buy the REITs in a one lump sum investment at a pre-determined price or just the current market price?
Or are you going to do dollar-cost averaging to build your position in the REITs?
Dollar-cost averaging means investing a fixed amount at fixed intervals of time.
For example, you can plan to buy $500 worth of REIT shares every month until you reach your allocation limit.
Both investment strategies have their own merits.
If you already have the money, you can make the one lump sum investment provided that the current market price is reasonable. (i.e not overpriced)
But, if you don’t have the money yet, dollar cost averaging will be good as you can set aside some money from your salary and invest it in REITs.
Well, buying is always easier than selling.
Your exit plan for your REITs investment largely depends on your investment objective.
If you are investing for retirement income, then you won’t be selling your investments for a long time unless the REITs you have bought are no longer a good investment for income and the REITs managers are doing a poor job.
But, if you are only buying REITs to grow your wealth and make money, then you must set a take-profit point.
Do you sell your investment once it has gone up by a certain percentage or it has made you a fixed dollar amount of money?
You have to decide on your exit plan beforehand, so you won’t be making any emotional investment decisions when the time comes.
Of course, you cannot just plan for the good times.
What if the REITs price goes down?
Do you have a cut-loss point?
For REITs investment, it’s generally a long-term investment.
For a long-term investment, you will certainly see volatility in its price.
For myself, if I think that a REIT is still a good investment for income and that any price weakness is caused by ( either one-off or cyclical) externalities but not structural, then I will still hold on to the REITs.
Finally, I recommend you do your own research before investing your hard-earned money in REITs.
One of the stock market research platforms I use is Seeking Alpha.
For Seeking Alpha, there are three types of pricing plans:
- Basic: Free
- Seeking Alpha Premium:
- Seeking Alpha Pro: $2400/ year (mostly for hedge fund managers)
Right now, there is a free 7-day trial for you to test drive it and see if it works for you. If you decide to get it, there is a special $50 discount for you by using this link.
With the basic free version, you can only get very limited access to Seeking Alpha stock in-depth news and analysis.
You also won’t get access to Seeking Alpha Author Rating and Quant Rating, Top-rated stocks, and all the premium stock analyses.
So, is it worth paying for Seeking Alpha Premium?
$189/year works out to be about $15.75/month (i.e. $0.53/day).
A cup of Starbucks coffee costs about $2.75.