Real Estate Portfolio Diversification With REITs

Today’s most prolific investors know it, and it’s about time you did, too: real estate portfolio diversification is a tried and true strategy that no entrepreneur should be without. After all, what separates today’s best investors from the rest of the pack, if not for a propensity towards risk aversion? At the very least, it’s those that can mitigate the most risk that stand the best chance of closing on a successful deal.

No investment opportunity is void of risk altogether. It’s a sad truth, but a reality nonetheless: there is an inherent degree of risk in every investment. However, it’s entirely possible to reduce the amount of risk you are exposed to on a daily basis. And those investors that can mitigate risk will find that the odds tilt greatly in their favor. Does that sound like something you would be interested in? Would you like to simultaneously reduce risk and increase your chances of realizing success?

If that sounds like something you could get behind, you are in luck. As it turns out, there is a single, universally accepted strategy to reduce risk: real estate portfolio diversification. Diversifying your holdings within the real estate industry can simultaneously open your career up to a new world of opportunities while protecting you from the cycles the industry has become synonymous with. What’s more, there is one diversification strategy I can’t help but remain encouraged by: real estate investment trusts (REITs).

Real Estate Portfolio Diversification At Its Finest

There is little doubt about it; the real estate industry is firing on all cylinders. Demand is strong, equity has returned in droves, and home values are stronger than we have seen in years. As a result, investors have found themselves the beneficiaries of a lucrative housing cycle; one that saw flipping take centerstage as one of the decade’s most popular exit strategies, but I digress.

It’s not enough to simply flip houses. As any investor will tell you, a great portfolio is a diversified portfolio. And while you won’t find more of a house flipping proponent than myself, I maintain that today’s best investors know how to diversify their portfolios. If you hope to realize success at the highest level, you must learn to mitigate risk, and nothing is more universally expected to reduce your risk exposure than diversification.

Fortunately, diversifying your portfolio doesn’t require you to leave the red-hot housing market. In fact, it’s entirely possible to diversify your portfolio by investing in more real estate. REITs, for example, offer investors a great way to diversify their holdings without ignoring the housing market’s potential.

As their names would lead you to believe, REITs award savvy investors the opportunity to invest in real estate without physically acquiring their own properties. Or, as REIT.com so eloquently puts it, real estate investment trusts are companies that own or finance income-producing real estate. “Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends,” says the worldwide representative voice for REITs and publicly traded real estate companies.

Not unlike their S&P 500 counterparts, REITs award savvy individuals the opportunity to invest in large-scale companies that have gone public and are currently on major U.S. indices, Just as you would purchase a stock, you can buy into a company that specializes in large-scale portfolios of properties. “In the same way shareholders benefit by owning stocks in other corporations, the stockholders of a REIT earn a share of the income produced through real estate investment,” says REIT.com.

It’s worth noting, however, that not every real estate company can be classified as an REIT. In order to boast the title of REIT, companies are expected to meet certain criteria. That said, to even be considered an REIT, companies must:

• Invest at least 75 percent of its total assets in real estate
• Derive at least 75 percent of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate
• Pay at least 90 percent of its taxable income in the form of shareholder dividends each year
• Be an entity that is taxable as a corporation
• Be managed by a board of directors or trustees
• Have a minimum of 100 shareholders
• Have no more than 50 percent of its shares held by five or fewer individuals

Those that have already placed an emphasis on real estate portfolio diversification through the use of REITs are more than likely aware of the benefits that may ensue. However, for those of you less familiar of what you may be getting into with REITs, it helps if you know just what’s in store. Namely, the benefits of investing in REITs.

For starters, and perhaps the sole reason you are reading this article, REITs offer investors a platform for real estate portfolio diversification few other investment vehicles can even come close to. It’s entirely possible to invest in a number of different types of REITs: hotels, office buildings, movie theaters, and just about any other form of commercial real estate. That means you can tailor your portfolio to specific industries.

Like where the data industry is heading? Consider investing in some data center REITs that specialize in warehouse storage. Does tourism have you bullish on the hotel industry? Maybe it’s time to look at some promising hotel REITs. The options are as plentiful as they are diverse.

In addition to diversification, REITs offer their faithful shareholders the potential to make money in the form of dividends. As I alluded to before, REITs must pay at least 90 percent of its taxable income in the form of shareholder dividends each year. As recently as the first quarter of this year, the FTSE NAREIT All REITs yielded 4.12% and the FTSE NAREIT All Equity REITs yielded 3.81%. As a comparison, the S&P 500 saw average yields reach 1.99% at the same time. In fact, REITs have outpaced the S&P 500 for quite some time now.

Outside of promising dividends, investing in REITs offers investors relatively easy access to their holdings. Perhaps even more importantly, investing in REITs increases your liquidity more than other investment vehicles. Seeing as how REIT shares can easily be bought and sold, it’s a lot easier to manage assets. That means you are able to manage your money as you see fit.

Real estate portfolio diversification doesn’t mean you have to choose between today’s most popular exit strategies: flipping, wholesaling and rentals. Of course, each of these is still a viable option, and something I would recommend in the right situation, but they are far from the only choices you have at your disposal. In fact, you are doing yourself a severe disservice if you neglect to look at other options. REITs, for example, offer investors a great way to diversify their portfolios, while still benefiting from today’s hot housing market.

Key Takeaways

• Real estate portfolio diversification isn’t relegated solely to physical assets. The most risk averse portfolios should also contain shares of REITs.
• Not only can REITs reduce your exposure to risk, but they have become synonymous with attractive returns.
• REITs have outpaced the S&P 500 for the better part of a decade, and would make a valuable contributor to most portfolios.