My grandmother (let’s call her NaNa), a shrewd businesswoman with a big heart, invested her family’s minimal excess income in real estate.
She started by buying a duplex. Her family lived in one part of the duplex and rented out the other half. Rental payments covered her mortgage, general expenses, and allowed for a bit of extra cash. Maintenance costs were held to a minimum, as my grandfather took care of repairs.
In time, NaNa saved enough for a down payment on a second duplex. With much of the rental income being deposited into a savings account, she soon had enough to buy a third property. Eventually, the family was rewarded the luxury of not worrying about taking care of their basic needs.
Nana Teaches The Son
Ever a keen and interested observer, my father learned from NaNa. She taught him a whole lot about property investing, including:
- What issues to consider when evaluating a potential purchase.
- Benefits of maintaining a property’s value.
- Importance of being fair and respectful to tenants.
- How to draw a budget.
Having the advantage of NaNa’s tutelage, a university education, and an extraordinary work ethic matched by ambition, by the time my father reached middle age, he had assembled a decent-sized portfolio of apartment buildings that he referred to as his retirement fund.
And all of this was accomplished in his spare time, outside of regular work hours. That’s just who he was. Some people play tennis for fun, others get their kicks out of working, building, creating.
The Next Generation Adds A Twist
In my late twenties, starting to accumulate savings, I considered following in my father’s footsteps and buying apartment buildings as a way to build wealth. But I didn’t. Not because I didn’t want to but because the cost of apartment buildings had rocketed out of my financial league.
Small, independent property owners like my father had been bought out by deep-pocketed corporations who owned and managed thousands of rental units across the country. These corporations are known as Real Estate Investment Trusts (‘REIT’).
The Beauty of REITS
Instead of taking on the risk of a huge mortgage to finance the purchase of an investment property, and spending time learning the nitty gritty of property management, I turned to REITs as a way to dive into real estate investing. But before I chatter on about why REITs are an excellent investment, one worth getting to know better, I’d like to offer a few chewy bits about this asset class:
- A Real Estate Investment Trust (short form: REIT, rhymes with ‘eat’), is a company that owns or finances income-producing real estate.
- Most REITS trade on public stock exchanges (i.e., New York Stock Exchange; Toronto Stock Exchange).
- REITS are income oriented and usually offer a higher dividend yield than most common stocks (the income component is one part of their attraction).
- REIT shareholders earn a share of earned income, and participate in capital gains (yahoo!) or losses (boo!) just as with any other company trading on a stock exchange.
- Commonly, REITS have a specific focus, such as apartment buildings, hotels, industrial facilities, office buildings, retirement homes, shopping malls, storage centers and student housing.
- REITs typically provide investors with a monthly income stream; most paying dividends anywhere between 2.5% – 9%.
- Think of REIT investing this way: the monthly dividend you receive is like collecting rent without the attendant headaches of managing your own property. Really, after you click to buy the REIT stock with your online broker, you can just sit back and watch your monthly dividend be deposited into your account each month. Sweet.
- Since 1991, as a group, U.S. REITs have outperformed the S&P 500, 11.2% to 9.1%.
- REITs are not highly correlated to the price of stocks and bonds. Meaning, since the price of REITS do not necessarily follow stock or bond market movements, they may play a part in smoothing out portfolio volatility.
For all these reasons, you may want to start a love in with REITs, in the wealth building sense that is. Ahem. That said, know that, like other asset classes, the finance gods did not create all REITs equally.
Hint, Hint: Be patient, and diligently research which REITs are a good fit for your portfolio.
Apartment Building REITS
Personally, I’m a big fan of Apartment building REITS, and not just for sentimental reasons. Rather, my crystal ball brings up images of a North America that is heading in the same direction as some Western European countries, where home ownership is much less prevalent.
Look at Switzerland, with home ownership at 38%, Germany at 41%, France at 55%, compared to about 68% in the US and Canada. Why the difference? Because property is so, so, so expensive in these countries that most people cannot afford to buy. And for a good percentage of those who do own a home, it was passed on to them by their parents, or grandparents or great-grandparents, etc.
So people rent. And that’s just fine. In European countries, there is no stigma to renting like there is in some pockets of North America where ‘the dream’ of home ownership in a white picket fence neighborhood is relentlessly marketed to us by the usual suspects: banks, mortgage lenders, home builders.
Not to mention the social pressure we feel from friends and family (after all, we are encouraged to live our life in a similar if not the same manner as those who came before us). And, our own dark angel contributes to the desire for home ownership: the human propensity to covet thy neighbor.
Now, this isn’t to say that there are not thoughtful, legitimate, excellent reasons for owing a home such as:
- Control. The house is yours. Do whatever you want with it, repairs, renovations, etc.
- Stability. Unless you go into default on your mortgage, no one can force you to move.
- Capital Appreciation. You benefit from any property value increase.
- Forced Savings. Each mortgage payment gives you more equity in your home. Especially important for those who are challenged in the … I Really Don’t Want to Think About Investments Because It Hurts My Brain department.
Okay, so you see, I’m not anti-homeowner. Not one bit. To borrow a phrase from two creatures who live with me known as ‘teenagers’, I’m ‘just saying’ that renting is a viable alternative, sometimes a preferred alternative depending on several factors including how pricey property is in your town.
And as property values continue to increase, outrageously in some urban centers such as San Francisco, Vancouver, Manhattan and Toronto, more people turn to renting. The result being that apartment buildings maintain high occupancy rates, which is good for apartment building REITs, and puts a smile on the face of REIT shareholders as they reliably collect monthly dividend payments.
Crunch, Crunch, Crunch the Numbers
My friend, Condo Lover, doesn’t agree. He says the better investment is a condo that you rent out. With a small down payment and mortgage financing to cover the balance of the purchase price, you’re now the proud owner of a condo.
But you don’t live in the condo, you rent it out. The rent payments cover your mortgage, maintenance and repair costs, and property tax. If you’re lucky, there’s change left over for spending money. So cash flow to cover condo costs isn’t a problem, and you sit and wait until property values increase to the point where you can sell the condo and cash out a sizeable capital gain.
I get it. I see the potential benefits of buying a condo as an investment. But if the condo is used solely for investment purposes, not as a second home, then I would take a pass.
Here are the primary issues, and the risks, I see:
- Assuming I don’t have enough in the kitty to pay all cash for the condo, I’m taking out a mortgage. What if I can’t find a solid, upstanding tenant who pays their rent on time each month, or who pays their rent at all? Will I still have enough to cover mortgage payments?
- If I’m going in with my eyes open, I’m factoring in repair costs, general maintenance, property tax and increases in property tax. Ideally, a steady stream of rent checks pays these expenses. But what if they don’t? Do I have other resources to cover expenses?
- What if I want to sell the condo but the real estate market is weak, the timing of sale is unknown, and I have to drop my asking price, possibly taking a loss? Am I prepared for this scenario? Could I absorb the financial hit without breaking stride?
Compare this to being a property owner via a REIT. I buy shares in the REIT with cash held in my investment account. I don’t borrow to pay for the purchase.
Buying on Margin. This is an investment term that means you pay for a certain percentage of your stock purchase and borrow the balance owing from the investment brokerage. DON’T DO THIS! EVER! Leave buying on margin for the speculators. It’s not for reasonable investors.
As a REIT shareholder, I don’t have to worry about bad tenants destroying my property or not paying any expenses associated with the property. And when it comes time to sell, well, I only buy fundamentally sound REITs, meaning there is always a liquid market (i.e., sufficient volume of buyers and sellers), so I can sell any time I like. I collect a monthly, purely hassle-free dividend (amount of dividend dependent on the individual REIT), and if I purchased a REIT when it was out of favor (i.e., price was down; we here at BuddhaMoney love buying investments on sale), there’s the opportunity for capital gain when I sell.
Now, tell me, what’s not to love about REITs?