26 comments

Become a Lazy Landlord – with REITs

Rich people come in many different flavors. Any established wealthy person knows that it is much easier and more profitable to have their money working for them, than to depend on using their own time and labor to work for money. That’s why we call our dollar bills employees here at MMM. But beyond this common agreement, the rich people diverge on the best way to dispatch their employees.

Some, like Warren Buffett, buy businesses – also known as buying stocks. If you buy good businesses when their stocks are on sale, you see a steady stream of dividend income and the stock price appreciates due to growth and profits in the companies.

Others, like a number of smiling bald men with grey beards I know in my own neighborhood, insist that owning rental real estate is the only way to become rich, and generate a nice cashflow during retirement.

I do a little bit of each myself, although to a much smaller degree than my Bearded Mustachian neighbors, since I have only a limited need for riches – enough to fund the MMM family’s excellent lifestyle, provide for plenty of future safety margin and allow random generosity a few times a year. Beyond that, the money would just be wasted on me since I’m not into powerboats, McMansions, or diamond rings.

So I’ve got this one rental house right now. The rent it brings in, after subtracting property taxes and other expenses, add up to 5.5% of the appraised value of the house. The rent goes up with inflation each year, and the value of the property also keeps up with inflation – or since there is a mild housing recovery going on in my area, it could be considered to slightly outpace inflation for a while until prices plateau out again. In other words, it is perhaps delivering a 6% return after inflation. And due to the major tax advantages of rental property ownership, the net income is closer to holding a stock that pays a dividend of 7% after inflation. Not a superb performance, since I actually have to do some work to manage the place, but due to our low living expenses, and the fact that there is no mortgage on either this rental or my main house, this house already more than funds the entire MMM family lifestyle. So all my other stock holdings, 401k accounts, and part-time income, and eventual social security payments in the distant future, are just gravy.

But as I’ve been landlording away all these years, occasionally having rather annoying experiences with tenants, I’ve been hearing and reading about REITs. Real Estate Investment Trusts. There are many advanced readers here who have been investing in and benefiting from these things for years, but there also many others who have never even heard the acronym before. So here’s a quick  summary before I present a few recent findings about REITs that make me feel like a fool for living off my rental house instead of letting someone else do the work.

REITs are a special category of company, only made available in the US in 1960. The key detail is that the company must invest most of its money in real estate to produce income, and it must distribute at least 90% of its income back to its shareholders.

So let’s learn more by zooming in on one of these funds as an example, which I heard about through a friend. It’s called Senior Housing Properties Trust – with ticker symbol SNH. According to the google finance link I just provided, SNH owns “320 properties located in 36 states and Washington, D.C. Its portfolio includes 226 senior living properties with 26,380 living units / beds and two rehabilitation hospitals with 364 licensed beds; 82 medical office, clinic and biotech laboratory buildings (MOBs) with 5.2 million square feet of space, and 10 wellness centers with approximately 812,000 square feet of interior space plus outdoor developed facilities. “

Holy Shit!! That sounds WAY more advanced than my rental house. As insurance for a continued string of good renters, all I’ve got is the fact that I have a very nice luxury house with low maintenance in a high-end neighborhood. Better than owning a slum unit, but look at SNH – if I buy that, I am diversified across 36 states, in a market that is very large, wealthy, and stable – SENIOR CITIZENS.

Even better is the dividend rate – 6.86%. In other words, his fund pays just as well as my rental house, but I don’t have to do any work. Even though the tax treatment of the REIT dividends (which get treated as regular income if I read correctly) is not quite as good as rental house income, it’s still a tradeoff I would gladly make.  Plus, you can buy any amount that you want – $1000 gets you $68.60 per year, $10 grand gives you $686, and throwing in 350 thousand gives you about $24,000 per year, which will theoretically automatically adjust for you with inflation – plenty to live on!

Other REITs own things like apartment buildings, office buildings, commercial or industrial developments – anything where they can get a good stable rent. Usually things that you as an individual investor would have a hard time lining up to buy all by yourself.

There are two components to any stock investment – the actual share price ($21.57 for SNH at the time of writing), and the dividend yield. Most stocks in the S&P500 index pay much lower dividends, because their companies retain their earnings in hopes of investing in more growth. With these stocks, you depend mostly on share price appreciation to grow your wealth – i.e., eventually selling them off in small chunks for more than you bought them. With REITs, you don’t care so much about the stock price, other than buying it low since that gets you a higher dividend yield (dividends stay the same regardless of share price, so if you can buy the shares cheaper, you are getting a higher percentage). For the record, the actual SNH share price has still outperformed the S&P index over the past 5 and 10 years, but underperformed during the last year.

When you look at the google finance link above, you’ll also see a bunch of “related companies”. These are other REITs, also with high dividends. To save you a few clicks, I have sorted them by highest dividend yield and pasted the list in here. The column on the far right is the annual dividend yield for each:

OHI Omega Healthcare Inves… 17.10 -0.05 -0.29% 1.75B 9.80
MPW Medical Properties Tru… 9.98 +0.08 0.81% 1.11B 8.19
HR Healthcare Realty Trus… 16.10 +0.27 1.71% 1.25B 7.62
LTC LTC Properties, Inc. 23.70 +0.70 3.04% 719.07M 7.40
SNH Senior Housing Propert… 21.57 -0.03 -0.14% 3.31B 7.00
UHT Universal Health Realt… 34.98 +0.07 0.20% 441.93M 6.60
HCN Health Care REIT, Inc. 45.88 +0.71 1.57% 8.12B 6.37
HCP HCP, Inc. 33.16 +0.62 1.91% 13.50B 5.93
NHI National Health Invest… 41.90 -0.24 -0.57% 1.16B 5.86
VTR Ventas, Inc. 47.50 +0.31 0.66% 13.68B 4.84

 

REITs like these are quite an amazing find if, like me just last year, you didn’t realize such high dividends were available at the click of a mouse. A source of easy income in exchange for moderate risk – a risk I will gladly take myself for some of my continued retirement income as the portfolio evolves.

 

  • Fu Manchu August 15, 2011, 7:17 am

    That’s great stuff, been interested in these for a while. What are your thoughts on REIT Index funds? Seems like any index fund…less risk, less reward (just looking, the dividends being payed are in the .69% – 1% as opposed to the SNH 1-2%).

    http://www.google.com/finance?q=MUTF%3AVGSIX

    Probably a year off until I dip my toes, still have to flesh out the bulk of my portfolio with S&P, Total Stock Market & Target Retirement funds (all low expense via Vanguard). But yet another fun thing to geek out over / track and analyze!

    Reply
  • Dwight August 15, 2011, 7:44 am

    Vanguard has an REIT. They list the risk/reward as “4” on a scale of 1 to 5. So- I wouldn’t want REITs (or anything else) to be my only income.

    REITs could be a way of diversifying if you put a portion of your money there while still keeping a good amount in stocks. There are times when REITs do well and stocks are down. The reverse is also true. That’s why we diversify.

    REIs also make sense for people who don’t own a home, but still want a portion of their money invested in real estate.

    Reply
    • Wiiksi Wallu August 17, 2011, 1:46 pm

      Although REITs might be considered risky investments for a retiree, the risk is hardly higher than that of owning rental property. REITs move together with the whole real estate market, for good or bad, while there are countless numbers of things that can happen to your own property.

      Prices could go lower (or higher!) in some local neighborhoods, regardless of the overall market, bad tenants could leave a big mess behind, or some expensive equipment could break — three months in a row. Lady Fortuna might turn against you for a few months.

      So remember to strive for good enough risk/reward ratio when working on the real estate part of your total portfolio. The great thing about REITS – also mentioned in the article – is that they can be bought in just the right sized chunks. They do have their place in the total asset allocation and as long as the portfolio is not too heavily oriented on real estate investments (one’s home might also need to be taken into account), one should be fine (in the long term).

      With REITs there is no simple way to positively affect the overall performance whereas with rental property you can really make a difference, like MMM has done by renovating, selecting the right tenants, etc. Some might want to rent out apartments simply because they like to deal with people, i.e they see it as an enjoyable, social activity. YMMV.

      Reply
  • Dan August 15, 2011, 7:34 pm

    Re: “Even though the tax treatment of the REIT dividends (which get treated as regular income if I read correctly) is not quite as good as rental house income, it’s still a tradeoff I would gladly make.”…

    In the long run they’re both treated identically for taxes. Net income from a REIT is taxed as ordinary income, same as net income (after depreciation, if any) from rental property. For the first several years of rental property ownership, though, you could to subtract from your income the depreciation on your original cost of the house. Once your house is fully depreciated, these will have the same tax incidence to you.

    And you’ll have to pay ordinary income taxes on the value of the house that was previously depreciated away, too (unless you move into it and live there for two years prior to selling). So really, owning a house versus a REIT have essentially identical tax treatments to you.

    Reply
    • MMM August 15, 2011, 9:47 pm

      Good explanation of the tax laws, Dan,

      But most landlords find the deferral to be very valuable. You own the rental house and do heavy depreciation while you are still an office worker raking in a huge salary, so you are dropped into a lower tax bracket. Then, you retire and live off of the rent from the house – and you STILL have never paid taxes on that depreciation benefit. If you keep it until you die, you never pay the taxes (your estate does, but you don’t care about that). OR if you sell while still alive, which I certainly plan to do, at least you do it in a year with little other income, so much of it is sheltered in the lowest tax bracket with the wonderful Standard Deduction, etc.

      Reply
    • Eric August 21, 2011, 9:43 pm

      Owning RE properties vs owning shares of REITS

      What about using leverage and the equity build-up of a smaller house to buy a bigger (house) property.

      How does investing in REITS allow the small investor to buy that same property without having to buy the exact amount of shares that it’s worth knowing he doesn’t have the money for it?

      Reply
  • Rich Schmidt August 21, 2011, 11:44 pm

    Hmm…. I wonder which gets me further ahead: investing $20,000 as the down payment on a house that I’ll rent out for 30 years or investing $20,000 in a REIT for 30 years?

    I really don’t have the chops to run the numbers quickly… but my gut tells me I’d rather own the rental property. The renters pay the mortgage (and then some), and once the mortgage is paid off, the income/return jumps.

    Just thinking out loud. We’ve gone the rental route and don’t have anything invested in REITs (that I know of).

    Reply
    • Tommy J August 22, 2014, 4:10 pm

      We are with you Rich…there is the very-longterm benefit once it is paid off, but perhaps the simplest way to “crunch the numbers” would be a quick glance at your rental income to mortgage plus taxes ratio. I think there is a place for REITs in any portfolio, but % of your portfolio is going to be different if you are owning and renting in San Francisco vs Sacramento (example being that I can get my mortgage back in rent in SF vs eating some $ each month on rentals in Sacrament0…if I had them of course)

      Reply
  • Blaine August 22, 2011, 2:19 pm

    Some things to consider:

    1) Look at dividend history. How long have they paid dividends? Do they show a culture for maintaining a share-holder friendly dividend policy? Or are they over-leveraged and cut dividends at the first sign of a recession? Are dividends consistent and increasing every year?

    2) How much debt does the company take on?

    3) What kind of dividend GROWTH are we talking about here?

    4) Interest Rate Risk: With highly leveraged REITS like NLY, they only pay out such a high yield due to their high debt at low rates. When rates rise, they’ll likely have to cut dividends.

    There are lots of great REITs out there, and to throw another one onto your list I’d mention O. I recently opened a small position in O and probably will hold it for a long time, buying more on dips. No debt, paid dividends for decades without cutting, conservative growth (both good and bad, only 3% dividend growth annually on average), pays monthly, raise dividend every quarter. The monthly is nice because re-investing dividends lets me buy more often during this choppy market. In the last dip you could get O for 6%, currently its back around 5.5% yield.

    Reply
  • Ademac August 22, 2011, 5:18 pm

    Before you get carried away on investing in REIT a word of warning.

    When the GFC hit and everyone panicked and tried to withdraw their money from the REIT here in Australia, they froze all redemptions and dividend payments for about two years.

    It caught a lot of people out who were relying on that money to pay for their retirements.

    So in the end “Caveat Emptor”

    Reply
    • Matrix June 23, 2012, 9:05 am

      What you said sounds like private REIT to me. Public REIT doesn’t suffer this problem. Public REIT won’t froze dividend unless the major tenant stopped paying rent.

      Reply
  • Dan August 22, 2011, 5:44 pm

    You should be careful investing in REITs, as many of the top performers in terms of dividends supplement their rental income by investing in mortgages. These REITS are also known as mREITS, and benefit enormously from the current environment of low interest rates, as they are basically performing the classing banking function of borrowing money at low interest rates and lending it at high interest rates. Expect to see divided cuts in many REITs when interest rates rise.

    Reply
  • Fu Manchu August 22, 2011, 6:48 pm

    @Blaine, Ademac and Dan – all good words of wisdom..thanks for sharing. Pushes me toward the Vanguard REIT Index VGSIX for less risk.

    Blaine, with more conservative 3% dividends from O, why not just go for VGSIX? Unless I’m not reading it correctly, looks like it has about the same dividend rate (quarterly dividends that add up to 3%) but you would get arguably the most diversity possible. That said, the fact that O pays monthly dividends is pretty sweet for exactly your reasoning – a type of dollar cost averaging (cheap shares in choppy markets).

    Take with a grain of salt because I am learning this stuff as I go.

    Reply
    • MMM August 22, 2011, 8:08 pm

      True, true – I definitely trust Vanguard funds to be more safe and conservative than individual REIT funds.

      Just to point out a couple of details about SNH in particular – I was pleased that it does have a history of increasing dividends since it was listed in October 1999. And they continued right through the 2008 property crash with no interruptions. Also, the price of the shares themselves are remarkably stable – outperforming the overall S&P index over most periods, and not really getting destroyed much more than the general stock market during the property crash. Also, as far as I can tell, SNH is not an mREIT, just a plain old property owner. Their leverage rate seems to be only 20% as well (i.e., their debt is only about 20% of the appraised value of all properties together).

      Reply
    • Blaine August 22, 2011, 8:58 pm

      Hi! Sorry I focus on Dividend *growth*. This means the yield is important, but more important is how that dividend is A) Sustainable and B) grows over time. AKA how to buy FUTURE high-income streams at a discount today.

      So with O you’ve got a 5.5% – 6% yield on today’s market, and your dividend payout GROWS every single year at 3-5%.

      Compare that to MCD for example, a classic “dividend growth rockstar”, who is growing dividends at about 15% per year since the late 1970s. With MCD, your 2.5% initial yield-on-cost if you bought today will be paying you double, or 5% yield-on-cost, in about 5 years (if they grow as they have in the past, which might be not possible). In 10 years it will have doubled again, for 10% yield-on-cost. Investors who wait 20 years get their original investment back every two years (because your’e not getting around a 50% yield-on-original-cost). I cherry picked this example for obvious reasons, but the point is the same – namely, you can’t ignore the *growth* of the dividend.

      Because O is only growing at a modest 3-5%, you’d expect your income from O to double every 18 years or so. So if you invest $10k in O now, you’re looking at about $550/year in income at today’s 5.5% yield (last week you could have snagged O for a healthy 6% yield). In 18 years you’d have grown to $1,100/year in income. [0]

      I hope this makes sense. Take care! -Blaine

      Also I’m a bit disappointed in the comment system here. I did put in my email address to be polite, but the comment system associated my comment with my hobby blog’s “gravitar”, which I did not intend to happen. There wasn’t any indication that this would happen and now I’ve crossed the streams. Bah.

      [0] look at how O’s dividend grows every quarter. Not by much, but grow it does. http://finance.yahoo.com/q/hp?s=O&a=09&b=18&c=1994&d=07&e=23&f=2011&g=v

      Reply
  • DTOM November 1, 2011, 3:18 pm

    Have you looked into Vanguard’s GNMA fund? Ticker VFIIX.

    It’s similar to an REIT but it invests in mortgage-backed securities that are guaranteed by the US government. All performance measures are better and more consistent.

    Reply
  • Pat February 28, 2013, 7:02 pm

    I’m working my way through your posts. My Dad left me some Riocan stock, it is great to have the steady income, and every time I pass a Riocan mall I smile. Tenants? Very diversified, and names I know – here is the list, from their website. Oh, by the way, we just had over a foot of wet snow here in Ottawa, aren’t you glad you aren’t here?

    >RioCan’s top 25 tenants are retail leaders and represent a spectrum of consumer products and services. In Canada,RioCan’s tenant list is comprised largely of the dominant retailer within the market. Of note, RioCan’s tenant portfolio is diverse, with no tenant representing more than 4.3% of total rental revenue. This diversity provides RioCan and its unitholders a stable cash flow stream and greatly reduces the exposure to any one particular tenant.

    1 Walmart
    2 Canadian Tire Corporation
    3 Famous Players/Cineplex/Galaxy Cinemas
    4 Metro/A&P/Super C/Loeb/Food Basics
    5 Winners/HomeSense/Marshalls
    6 Loblaws/No Frills/Fortinos/Zehrs/Maxi
    7 Staples/Business Depot
    8 Future Shop/Best Buy
    9 Target Corporation
    10 Shoppers Drug Mart
    11 Giant Food Stores/Stop & Shop (Royal Ahold)
    12 Reitmans/Penningtons/Smart Set/Addition-Elle/Thyme Maternity
    13 Harvey’s/Swiss Chalet/Kelsey’s/Montana’s/Milestone’s
    14 PetSmart
    15 Sobeys/IGA/Price Chopper/Empire Theatres
    16 Dollarama
    17 Zellers/The Bay/Home Outfitters
    18 TD Bank
    19 Lowes
    20 Chapters/Indigo
    21 Safeway
    22 Blue Notes/Stitches/Suzy Shier/Urban Planet
    23 Michaels
    24 The Brick
    25 Sears

    Reply
  • Evan Lynch April 20, 2013, 1:09 am

    I love my REIT – I can’t remember the exact return, but I got between a 11 – 13% appreciation on the Vanguard REIT that I’m invested with, for zero effort, unlike actually managing real estate yourself. That was only one year’s return, so it may not do that well every year, but so far so good.

    The REIT I’m invested in is Vanguard’s VGSIX.

    Reply
  • Propertymom June 18, 2013, 2:48 pm

    If I am doing the math correctly, then are you saying your rental house is worth over $400,000? Whoa.

    Love your blog; thank you for writing it!

    Reply
    • Mr. Money Mustache June 18, 2013, 3:43 pm

      Unfortunately, yes – if you read enough of the blog you’ll see why I have this inefficient rental house. Long-term goal is to sell it and have a nice duplex or 4-plex with similar value but much higher rent.

      Reply
      • Propertymom June 18, 2013, 3:55 pm

        I just started reading your blog 2 weeks ago; found it thru Early Retirement Extreme. I’m reading from the beginning, so more will become clear as I progress. Looking forward to reading more!

        Reply
      • Brian October 4, 2013, 7:54 am

        MMM love your mind not sure I can take a far as you but i am trying

        Do you have any ideas for me I would like to be free in 10-15 yrs
        I am 35 yrs old with a gross income of 100k and 15% paid to taxes because of my real estate and 401k deductions
        180k in vanguard investments 401k
        100k cash
        900k in rental properties with mortgage of 760k 5% rate can’t refi bad fico score
        Monthly rental mortgage + expenses 6k
        Rental income 5k per month
        I have a free car and live in one of my rental units so my living costs are low I save 50% of my take home pay
        Any thoughts would be greatly welcome

        Reply
        • GM October 13, 2013, 8:38 am

          Try “Ask a Mustachian” in the MMM forum if you want personalised answers to your individual situation.

          Reply
  • Taylor October 7, 2013, 2:08 pm

    I know this is late to the game, but I’ve been reading through posts from the beginning and it takes a little while.

    A great place to hold your REIT is in a Roth IRA because the dividends are able to grow tax free. Obviously you want a well diversified portfolio but if you’re trying to decide which pile of money to purchase a REIT from it should be that one.

    Reply
  • Clinton January 21, 2014, 10:35 pm

    If you start a business, the harder you and your employees work, the more money you can make. The richest people in the world got rich this way. Bill Gates got rich from starting Microsoft, Sam Walton got rich from Wal-mart. The Johnson family got rich from Johnson and Johnson, etc.

    Starting/Owning your own business:
    Advantages: Ultra high rate of return. Tax deductions.
    Disadvantages: Hard work, time could be spent doing something else, and earned income is taxed up to 35% plus payroll taxes. Repayment of borrowed money plus interest, that is used to grow the business. Lack of diversification.

    VS

    Investing in stocks/mutual funds:
    Advantages: Medium(index funds), high(undervalued individual stocks), very high(the next Microsoft, Wal-mart, Apple) rate of return, no work, spend your time doing what you want, very tax friendly(long-term capital gains and qualified dividends are tax at a max of 15%). $3,000 yearly capital loss from income deduction. Extreme diversification at extremely low cost. For the cost of one share of VT, you can own a piece of every company in all the stocks market of the world.
    Disadvantages: Risk

    Renting:
    Advantages: Higher return or same return as a REIT. Tax deductions.
    Disadvantages: Work. Repayment of borrowed money plus interest, that is used to buy the property. Lawsuits. Property tax. Insurance. Vacancy. Tenants that do not pay rent or make late payments.

    VS

    Investing in a REIT:
    Advantages: Medium(VGSIX), high(individual REITS) rate of return.
    Disadvantages: Risk

    Reply
    • Rich January 22, 2014, 9:45 pm

      To be fair, Clinton, “risk” should be listed as a disadvantage for all of those. Some businesses fail completely, with their owners losing everything. That includes landlording businesses.

      We’ve gone the landlording route anyway, because we think the risks are worth the (current but mostly future) returns.

      Reply

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