Investing in REITs can be daunting for those unfamiliar with the unique terminology and strategies involved. However, stepping outside the realm of traditional stock investing can yield rich rewards. In this article, we will explore a step-by-step process for building a REIT portfolio from scratch that will generate monthly "rent checks."
Step 1: Individual REITs or REIT ETFs?
In the past, individual REIT securities were the only option for investing in the sector. However, the introduction of mutual funds and exchange-traded funds (ETFs) changed the game. While we oppose mutual and private funds due to their high fees, ETFs offer a low-cost way to gain diversification and access to the financial markets.
The pros of investing in REIT ETFs include instant wide diversification, low time commitment, and lower expense ratios. On the other hand, individual REITs provide the opportunity to hand-select your portfolio and eliminate expense ratios. At High Yield Landlord, we prefer investing in individual REITs for greater control and potential outperformance.
Step 2: Where to Find Great REITs
When searching for REITs, focus on small-cap, internally-managed REITs with unique business models that generate alpha. Look for REITs that have a long streak of consecutive dividend increases and have recently sold off to sizable discounts. Dividend growth streaks demonstrate consistent performance and shareholder-friendly management.
Step 3: Assessing Attractive Pricing
Paying too high a price for even high-quality REITs can result in poor investments. Look for blue-chip REITs trading at or below their historical average price-to-FFO (funds from operations) ratio. Additionally, compare the price per share to the net asset value per share to identify undervalued opportunities.
Step 4: Finding the Right Balance
Diversification is key, but there is a tradeoff. Holding around 15-20 REITs provides over 90% of the maximum benefit of diversification. Holding fewer REITs allows for greater investment in your best ideas and reduces the time commitment of managing a large portfolio. Ensure diversification by investing in different sectors to gain exposure to various types of great real estate.
Step 5: Portfolio Building Strategy
Building a diversified REIT income portfolio takes time. Start with the highest conviction ideas and gradually add strong diversification over time. The best investments are long-term in nature, providing a competitive advantage over institutional investors. Sell a REIT when it loses its competitive advantage or becomes wildly overvalued.
Step 6: Adopting the Landlord Mentality
Investing in publicly-traded REITs exposes us to daily price volatility. Adopting the mindset of a landlord investor helps keep emotions in check. Focus on simplicity, income, predictability, and long-term orientation. View REITs as real estate investments rather than stocks, with a disciplined approach that emphasizes compounding and long-term performance.
Bottom Line
REIT investing is crucial for building a portfolio that generates growing dividend income in retirement. With the average retirement age increasing, REITs offer passive income and inflation-resistant returns. While ETFs may be easier for inexperienced investors, combining expertise with a dedicated approach to identifying undervalued REITs can yield considerable alpha in the long term.
Source: SAIGONINTELA
