Some of you might have clicked on the title of this article maybe because you think it might be a joke or that it involves some sort of elaborate real estate investment scheme. But before you jump to any conclusions about anything, allow me to first share a personal experience.
Ever on the lookout to find out how to make my money work for me, i.e. leveraging my money through investing it, before I learned about the power of stock investing I was set on someday owning a rental property and moving up from there. I thought it was the only way to own property and so I was always on the lookout for a good opportunity.
What started this desire was the story of an uncle of mine. He started out by buying both halves of a duplex, living in one half and renting out the other half. The rent from the one half paid for itself plus for most of the second half. After saving up a down-payment, he next bought a bungalow and moved into it while the rent from both halves of the duplex paid not only for themselves but also for most of the mortgage on the bungalow. It wasn’t long before the duplex was entirely paid for and then his house mortgage was covered by the duplex rental income. In this manner he built up a good degree of the wealth he has today; as an aside, he built up the remainder of his wealth through being a very disciplined saver plus investing in stocks.
Although this story had inspired me to look for my own rental property, three factors prevented me from doing so. First of all, I didn’t want to take the risk involved in owning a rental property. I would have had to really extend myself financially, i.e. get into a lot of debt that I was not comfortable with in order to buy one. Secondly, I didn’t want the work involved in owning a rental property. As the years passed, I ran into more and more landlords who were constantly complaining about how repairs and upgrades often meant a minimal return on their investment. To save on costs, many of them devoted a lot of their spare time to do these repairs and upgrades themselves, taking time away from job and family. Even when the collected rent was totally covering the mortgage, there was barely enough left over to go toward paying down the mortgage on their own property or any nest-egg they built up was going toward maintaining their rental property. So even though they were building up equity, their investment wasn’t boosting their monthly income by any meaningful amount.
Third, I had heard too many stories, from people I did and didn’t know personally, who had basically gone through a living hell with their renters. One landlord that I know has not only had his property trashed but he was even once taken to court because his tenants were upset that he didn’t replace their refrigerator quickly enough – and the tenants won to the tune of several thousand dollars, claiming negligence on the part of the landlord. I’ve learned from this and other accounts that tenant rights largely trump landlord rights no matter how outlandish the claims of the tenants are.
I asked my uncle years later whether he thought I should do what he did and he told me that the hassle wasn’t worth it. He eventually sold his duplex because the constant issues with lousy renters was driving him crazy. He and others basically told me that being a landlord was anything but sitting back and enjoying a passive secondary income, that instead it was a business that consumed a certain portion of one’s spare time and money and sometimes a lot.
After considering all of these factors, I decided to give up on this dream of becoming a landlord myself. I thought that there had to be a better way to make my money work for me.
Some of you reading this might be critical of these landlords, thinking that they are inept or that they could have handled things better. Better screening of potential tenants. Stricter rental contracts. Hiring a property manager to collect rent and deal with tenants face-to-face instead of doing this themselves. Some of you might be critical of a person like me deciding not become a landlord by allowing all the negatives to outweigh the potential positives. After all, are there not also many successful landlords?
In any case, whether due to aversion to financial risk or not wanting to have one’s life consumed by dealing with the rental property and tenants, becoming a landlord is simply not for most people. But what I didn’t realize is that I had only learned about being a landlord in the traditional sense. It was only after I gave up my dream that it was re-realized but in a way that I had never before known.
A few years ago, after I had discovered the power of stock investing, I was looking for higher dividend-paying holdings for my wife’s RRSP – the Canadian equivalent to an American 401(k) – when I started coming across all of these Canadian holdings with a “.UN” at the end of them, after the stock ticker symbol. I discovered that these were called REITs, or Real Estate Investment Trusts, and I was perplexed at why my search for higher dividends kept turning these up versus regular stocks.
Upon some investigation, I learned that REITs invest in real estate through property or mortgages and often trade on major exchanges just like a stock. In the U.S. they are corporations but in Canada they are unincorporated investment trusts, as denoted by the “.UN”. In short, a REIT provides a way for a person to own property without all the hassles involved with being a landlord.
So what are the advantages to owing a REIT versus physically owning a rental property or properties? In listing some of these it will become clear about how one can become a landlord but with none of the hassles.
In short, a REIT provides a way for a person to own property without all the hassles involved with being a landlord.
1) Minimal up-front cost
Whereas one might have to put down at least several thousands of dollars to buy a rental property, minimal investment in a REIT is no more than the minimum amount required to buy a stock, often no more than a few hundred dollars.
2) Generous dividend payments
While U.S. REITs typically pay quarterly dividends, most Canadian REITs pay unitholders monthly. These yields are typically high. Most Canadian REITs, for example, pay an average of 4% to 10% in annual dividend yields, but before you start salivating too much you’ll have to do your own research to determine if a particular REIT with a high dividend is able to sustain it.
Specifically, you need to look at the adjusted funds from operations (AFFO). A company with an AFFO amount below its dividend payout amount means that it can’t keep up paying the shareholders. A REIT that can increase its AFFO will be able to increase its distribution to shareholders. One source (listed below) considers a warning sign to be an AFFO above 90% for a sustainable period of time. That said, a REIT paying a 4% annual dividend may not be sustainable whereas a REIT paying a 9% dividend might be entirely sustainable. Again, the AFFO amount is the difference.
Do your own research to determine if a particular REIT with a high dividend is able to sustain it … the AFFO amount is the difference.
What happens if a dividend is not sustainable? The dividend will likely be cut, which means less passive dividend income for you, plus this often sends investors rushing to the exits which sends the unit price of the REIT down. So you stand to lose not just dividend income but also a good chunk of the original money you put into buying the REIT. Therefore, knowing the AFFO of a REIT is crucially important!
3) Easy in, easy out
This is a simplified way of stating that a REIT provides investors with an extremely “liquid” stake in real estate; that is, they can get into and out of their investment quickly and easily, no differently than buying or selling a stock. Contrast this with the paperwork, cost, and other hassles involved with buying or selling a physical property.
4) Many property types
Owning a REIT means that you can be invested in more than just residential properties. There are different types of REITs that you can own besides residential: retail/commercial, industrial, healthcare (ex. medical office space, nursing and retirement homes), mortgage (these buy mortgages or mortgage-backed securities instead of physical property), and hybrid (a combination of equity and mortgage REITs). Pick the type that interests you the most or find a “diversified” REIT that owns properties of more than one type. The more diversification, the less risk.
5) Lower risk
Speaking of less risk, instead of staking your hopes on one or a few physical properties, a typical REIT owns dozens of physical properties and therefore your risk is minimized; if one building burns down or has high vacancy, it isn’t likely to affect the overall health of the REIT. If the holdings are also spread over a large geographic area and comprise more than one property type, one’s risk is minimized even further.
6) The REIT takes care of all the hassles!
The REIT researches the properties, buys them, finds tenants, collects the rent, deals with tenant issues, and takes care of the repairs and maintenance.
The Final Word
A person with significant physical real estate holdings may want to skip holding REITs altogether, but for most people REITs offer a far easier and less stressful way to become landlords.
Even though REITs offer the above advantages, they can be risky investments just like anything else. Therefore, as with any investment type, they should make up only a portion of your portfolio. One of the sources listed below suggests that REITs make up about 10% to 15% of your portfolio.