My 1st Million At 33 - yes, you can do it too

REIT is the abbreviation of Real Estate Investment Trust. To qualify as a REIT, the company must pay out 90% of its taxable income or FFO (Fund From Operation) to avoid paying corporate income tax. With this tax advantage, investors can own REIT as if they’re the indirect owners of the real estate properties. There are many kinds of REIT:

1. Equity REIT: This includes residential, retail/commercial, office/industrial, and some smaller categories like healthcare, self-storage, and hotel REIT. There are companies out there, specializing in each category, and a few are diversified REIT that owns several kinds. Their income comes from leasing out of their owned properties.
2. Mortgage REIT: These kinds of REIT invest in mortgage securities, such as Fannie Mae and Freddie Mac. These companies take advantage of the yield difference by using short term funds to invest in long term bonds and produce earning by the yield difference. When times are good, they’re like a money-printing machine. But when the yield curve flattens or even inverts, looks down below when the dividends are cut. In fact, I wouldn’t touch these companies at all, since the “asset-back” mortgage securities are often back by overvalued assets. I fear for the non-return of my total principal.
3. Hybrid REIT: Hybrid REIT combines investment in both equity and mortgage REIT.

REIT usually is a fairly good way to obtain a stable dividend income, while at the same time, your money is invested in an inflation-hedged real estate property. Both the current dividend income and the principal money in the real estate property will rise along inflation. In this regard, REIT is an excellent choice of investment between stocks that only provide inflation hedges without much dividend incomes, and bonds that only provide a stable fixed income without any inflation hedges. In fact, the performance of REIT in the last five years of roughly 20% a year attests to its stellar investing characteristics.

In the recent past before roughly 2001, REIT used to be paying out a fairly high dividend usually north of 7%, up to 12%. I invested in REIT in year 1999 to probably 2001. Since then, I stopped investing in REIT for the following reasons:

1. I owned my home, and to prevent further real estate exposure, I don’t want to invest in REIT in respect to my asset allocation.
2. The yield on REIT is relatively low, and keeps getting lower as the REIT stock prices keep going up much faster than the actual income to be distributed as dividends. When I first started investing in REIT, the bigger names had close to 7% yield, while the smaller names can have up to 12% yield. Now, the bigger names have a paltry yield of 3%, and it’s simply too low for my taste. Here is the historical yield range for REIT, and as you can see that REIT is yielding at the lowest in years.
3. Obviously, if and when the real estate prices go down because of a housing market correction, REIT stocks will inevitably go down because of the shrinking property values. Especially if REIT stocks go back to the historical average yield of roughly 6% to 7% for bigger names, REIT stocks could fall very hard. For example, for a current yield of 3.25%, and a stock price of $100, and assume it’s total dividend stay the same at $3.25 per share. If the dividend yield reverts back to 6.5%, the stock price needs to fall back to $50 since $50 * 6.5% = $3.25 per share. In other words, majority of the REIT stock capital gain is coming from the shrinking of the yield due to the perception of the rising real estate. CNN Money also agrees with me on that REITs are getting riskier at this point.

To read more on REIT investing, here are a couple of good resources:

1. For Canadian REIT investors, here is an excellent source of information from Deloitte.
2. Investopedia explains how REIT can be properly evaluated using its FFO.
3. A brief intro from Forbes on REIT investing.