What is a REIT?
REITs are corporations that specialize property investments. They use real estate to generate a stream of income which they share with their shareholders. REITs specialize in diverse real estate areas such as management, renovation, development or leasing. REITs invest in all types of property; Industrial, R&D facilities, labs, office buildings, shopping malls, golf courses, cinemas, bowling allies and even prisons. There are two types of REITs. Equity REITs, they own properties and mortgage REITs they lend money.
REITs are managed by professional property managers who’s bonuses depends on the performance of the REIT.
REITs benefit from special tax benefits, in order to do so they must have 75% of its assets in real estate and 95% of a REITs income must derived from real estate activity. This is a brief introduction on the concept of passive income.
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Why are REITs a good option for passive income?
REIT are an excellent vehicle for passive income, because
- They provide a way of becoming a landlord without the hassle of owning property. Leanr more on how to find a suitable investment property adapted to your skills and resources.
- 90% of a REITs income must be distributed to stock holders. This is gives investors a strong legal assurance that a dividend will paid. Divdend stock investors do not have such a guarantee.
- REITs specialize in a property type and a market which makes them more efficient than a small landlord and give investors the flexibility to invest in specific markets.
- REITs are professionals and they can increase profits and cut costs much better than any individual landlord can. They increase their bottom by getting higher paying tenants in, upscaling their properties and charging the tenants more.
- Being a landlord means a considerable time commitment. A REIT has the power to diversify nationally and internationally more than an individual landlord
- A REIT can protect itself from legal action much better than an individual landlord.
- Some properties such as shopping malls and restaurants are not accessible to individual.
- REITs are more liquid than individual property. This gives investors the best of both worlds. First a stream of passive income from property and secondly liquidity
- Specific property deals are only available to a select network of individuals. REITs are part of these networks.
- Timing the market is difficult even for professionals. The property market experiences a series of booms and busts. Good REITs can manage their accounts accordingly and prepare for both the good and bad times. They do this through diversification and smart funding.
How to find a good REIT that can provide dependable passive income.
It is possible to diversify within REITs, by buying several of them or buying a REIT ETF Consider https://investor.vanguard.com/etf/profile/portfolio/vnq
Experienced CEO and management team. A strong team of executives who have experienced several market cycles in different markets and geographies is a key factor in finding a good REIT. This give the REIT the brains to navigate both the good and bad times. Such a management team should have gone through many property deals. They know how to to make deals, increase rents and cut costs.
- Conflict of interest. A management team who owns the REITs stock is always a good indicator, as it aligns the interests of the stock holders and the management. Any reports of the REIT buying overprices property, selling at a loss, or buying property owned by known associates is a bad sign. Consider that not all REITS are governed by the same regulations.
- REITs need to borrow funds to purchase property. The danger is they can borrow too much. High debt servicing cost reduces profits. Short term debts that cannot be paid, can cause serious financial troubles. Consider the maturity of the debt and the ratio of debt to market capitalization, especially for small REITS under 600 million of market capitalization. Learn more on how to start earning passive income from property without actually owning a property.
- Investment focus. The sector in which the management team have experience in and the focus or the REIT.
- Cash position. What are the short term funds of the REIT.
Outside factors: Laws, Regulations, Supply / Demand and Interest rates. Laws and Regulations can have an impact on the supply / demand of property and also on the costs and income of a REIT. Interest rates have an impact on financing. The higher the interest rates the higher the cost of capital
REIT stocks tend to trade above the value because of their liquidity and the ability to generate a passive income stream. This premium is the price of serenity and risk. Landlords have to work so their properties are not 100% passive income. REITs is an excellent took in the tool box of those seeking financial freedom through passive income. Lear more about how to create different forms of passive income and the different types of passive income.