This 1960 Law Made Commercial Real Estate Investing Possible

May 13, 2020

REITs investing

According to fairy tales and romantics, every person has “the one” waiting out there for them: a lone individual who’s tailormade for you and you alone.

All due respect to both (since both can be exceptionally useful in their turns)… But I’m going to have to disagree on this one, at least to some degree.

For “one” thing, what about those who loved and lost, only to find another true love out there? And what about if you find that special person, only to behave badly enough that they leave you.

Does that mean you’re forever doomed going forward? That you should either beg your ex for forgiveness until he or she takes you back – which could be seen as stalking, a rather illegal act, for the record – or confine yourself to a romantic love-less existence?

That seems a little harsh, if you ask me. It seems much more empowering and practical to simply work harder at being “the one” for someone you’re compatible with. With “work” being the keyword.

It takes, time, effort, commitment, understanding, and a whole lot more to maintain a healthy relationship.

In that, it’s very much like holding onto a worthwhile portfolio. It doesn’t just fall into place. You have to build it. And then you have to preserve it.

Otherwise, it might feel neglected and end up leaving you someday.

There’s No Perfect Stock, Only Really Worthwhile Prospects

Here’s another way I equate relationships with stocks: There is no such thing as a perfect one.

When it comes to humans, we all have the choice to react negatively to our surroundings, whether good or bad. And we too often do precisely that.

So it stands to reason that, when people are in charge of a publicly traded business (and they always are)… they can take it down a professional, profitable path. Or they can run it poorly.

There’s also the possibility that they simply fall on hard times through no fault of their own.

That’s why there’s no such thing as a perfect investment.

I know it’s nice to think otherwise. It’s comforting to believe we never have to worry again should we only pick the right set of shares.

Since that’s not a realistic option though, I choose to work for it, researching and analyzing and acting on the best conclusions I can reach.

And the conclusions I’ve reached so far point me to putting large portions of my portfolio into real estate investment trusts. As the late and great Ralph L. Block wrote in his Investing in REITs (fourth edition):

“... those looking for above-average current returns, along with reasonably good price appreciation prospects over time – and with only modest risk – will certainly want to consider apartment communities, office and industrial buildings, shopping centers, and similar investments. In other words, commercial real estate that can be leased to tenants to generate reliable streams of rental income.”

Now, obviously, that was written before the government shutdowns. Also obviously, it was written before the retail apocalypse was first mentioned, much less became a full-blown issue.

(The book was published in 2012, for the record.)

But that doesn’t mean the principle behind it falls apart. Far from it.

A History of REITs

To understand how and why that is, you have to know the what and when.

REITs received legal existence in the mid-1900s. Through the Real Estate Investment Trust Act of 1960, ordinary investors were able to do what large institutions already could: profit from diversified collections of commercial real estate.

That was a big deal. So too were the exact details REITs were told to operate under. To quote Block again:

“A key hallmark of the REIT structure is that the REIT can deduct from its pretax net income all dividends paid to its shareholders – thus, the REIT pays no corporate taxes if it distributes to shareholders all otherwise taxable income.

“By law, however, it must pay out at least [90%] of its net income to its shareholders. The shareholders, of course, must pay income taxes on the dividends, unless the REIT shares are held in an individual retirement account (IRA), 401(K), or other tax-deferred account.

“Often, however, a portion of a REIT’s dividend is not immediately taxable, and another portion may be taxable at lower capital gain rates…”

There were, admittedly, a few issues at first. But then came the Tax Reform Act of 1986, which relaxed some unnecessary restrictions involved.

For instance, REITs initially had to hire outside sources to run their properties. Now that’s an option, not a rule. This allows them to have more room to implement their vision and less expenses to worry about.

As a result, Nareit accurately notes how:

REITs historically have delivered competitive total returns based on high, steady dividend income and long-term capital appreciation. Their comparatively low correlation with other assets also makes them an excellent portfolio diversifier that can help reduce overall portfolio risk and increase returns. These are the characteristics of real estate investment.”

Which brings us to today.

2 Monthly Paying REITs To Buy

We’ve now have tracked 41 equity REITs in our universe of 165 names to announce a cut or suspension of their dividends in addition to the majority of mortgage REITs that have announced dividend cuts or suspensions.

REITs are now lower by roughly 22.0 percent this year compared with the 9.1 percent decline of the S&P 500 and 14.5 percent decline on the Dow Jones Industrial Average.

The top-performing REIT sectors of 2019 have continued their strong relative performance through the early stages of 2020 as data centers and cell tower REITs remain the real estate sectors in positive territory for the year, while industrial and residential REITs have also delivered notable outperformance.

While Covid-19 has certainly impacted most every REIT property sector, we are screening for REIT shares that offer the best risk-adjusted returns. And our favorite names are two net lease REITs – Realty Income (O) and STAG Industrial (STAG) – that are yielding 5.7 and 5.9 respectively.

By owning shares in these two high-yielding REITs, you are essentially owning shares in businesses that generate durable sources of income with strong liquidity. And most importantly, you don’t have to worry about the headaches that go along with owning direct real estate.

REITs are essentially the ultimate vehicle for “crowd funding” and if you do your necessary due diligence, you are almost certain to sleep well at night, even during these turbulent times.

I own shares in STAG and O.

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Investing in the commercial real estate space is a great way to enjoy passive income while watching your investments grow. In an uncertain market like today, CRE investment can bring stability to your portfolio.