Investing in real estate can bring significant income and long-term gains, and there are many ways to do it — including the hard way and the easy way.
The hard way is investing directly. Regarding rental property, it doesn’t matter whether the property is residential, industrial or commercial. Keeping it leased, maintaining it and dealing with tenants involves considerable time and expense. The angst involved can be a real pain for those who don’t do this for a living, as these chores can seem like, or actually be, a full-time job. And a lot of spare time is something most physicians just don’t have.
But there are some indirect ways to invest in real estate that take very little time and are relatively angst-free.
One of the best ways is to buy shares in REITs, or real estate investment trusts. These landlord companies own lease out all types of property and sell shares of their businesses to investors who collect income and can sell appreciated shares for gain. Known as pass-through entities, REITs have a special tax status that requires them to pass 90% of their profits along to shareholders in the form of dividends that are generally far higher than stocks and usually far higher than bond yields, making them attractive as an income-yielding alternative to bonds that still has the growth potential of stocks.
While they’re cheap
As with most investments, the best time to buy is when they’re cheap, provided that they hold growth potential. Now is such a time for REITs.
As of mid-October, the Vanguard REIT index was down 35% since the stock market peak in early 2022. And REIT valuations are now at a seven-to10-year low.
The factor that has made REITs cheap is the same one that has made investing in property directly quite costly: elevated interest rates. Mortgages on residential property currently carry rates of 7% to 8% for 30-year fixed-rate loans, up substantially from the 2%-to3% rates available less than three years ago. This increase in the cost of money, which has roiled many parts of the economy, stems from Fed rate cuts intended to contain inflation by suppressing economic growth. The nation got hooked on the ultra-low rates the Fed set to jump-start investment after the pandemic-induced economic trough in 2020. Many, especially younger, borrowers aren’ft aware that current mortgage rates aren’t really all that high, because they’re about the average figure over the past 30 years.
Anyway, these higher rates have prompted analysts to downgrade many REITs, in part because of their big increases in financing costs in recent years from higher interest rates. Residential REITs are still challenging, but if historical trends are any guide, these should improve with the overall category after the current, almost finished Fed rate-hiking cycle ends; REITS in general have tended to start growing in value in the months following the end of rate-hiking cycles by the Federal Reserve board. Valuations are at a seven- to 10-year low.
While residential REITS (apartments and rental homes) are generally a good investment, they’re currently challenging.
Commercial REITS are another story, although office building REITS, which still suffer from employees’ working from home, are an exception. Eventually, they will improve as more employees are required to work in the office, boosting occupancy rates, and buildings that don’t come back are converted to apartments.
With the already strong economy perhaps poised to strengthen further once interest rates level out — and to grow apace once rate cuts inevitably begin, likely next year — two types of REITs are positioned for near-term growth. One of these is warehousing, which always grows when the economy does. An exemplar in this category is Prologis (PLD), which owns beaucoup warehousing in and outside of the U.S. Another area worth considering is specialty leasing. Alexandria Real Estate (ARE) leases customized facilities for medical research, with extensive holdings in the Research Triangle of North Carolina, where many institutional tenants operate with the aid of government research grants. Shares are in a deep trough — down more than 36% YTD as of Oct. 31st — but couldclimb out of it in the coming months. The company has a 5% annual dividend and no debt maturing until 2025, and is nicely positioned in the growing medical field, fueled by continuing demand for new, inventive therapies to care for boomers.
One perennially lucrative area is gambling. VICI Properties (VICI) owns various big-name casinos in Las Vegas whose name-brand business owners are renters. VICI’s price is attractive, as shares haven’t performed well this year. And the annual dividend yield is quite healthy, around 6%
Another type of commercial REIT category currently worth considering is cell towers, the ubiquitous installations where various digital entities rent space to route signals. A good example of this proven REIT variety is Crown Castle (CCI), one of the top owners of cell towers leased out to mobile phone providers.
Putting buckets out while it rains
Another currently advantageous way to invest in real estate indirectly is to buy homebuilder stocks.
These companies benefit from an unusual scenario of high demand and rising home prices amid higher rates, with supply severely constricted by homeowners’ reluctance to sell out of their low-rate mortgages and buy into new ones with rates two or three times higher. This has made listings of existing homes as rare as hens’ teeth, so a disproportionate amount of the supply is new homes, which many buyers prefer anyway.
The current shortage is just a continuation of a long-term shortage of places to live in this country. For decades, supply hasn’t kept pace with rising demand: Generation X buyers and now millennials getting their first homes, divorces causing one household to become two, baby boomers seeking retirement dwellings, and population growth, largely from immigrants of home-buying age.
Meanwhile, homebuilding over the last decade has lagged behind averages in prior decades by 5 million homes. The shortage was exacerbated by construction pauses during the pandemic.
With few existing homes on the market, the solution for many buyers is a new home. This scenario of high demand and scant supply has created an ideal market scenario for homebuilders, and they’re putting out their buckets while it rains.
Amid today’s recently elevated interest rates, such companies have a powerful draw for homebuyers: cheap financing. Their financing departments can offer discounted rates because instead of discounting the price of the home, they use that profit margin to buy down the mortgage rate through the lender. So instead of an 8% rate today on a mortgage for an existing home, buyers of a new home from a building company might be able to get 6.5%.
Two proven performers in this category are D.H. Horton (DHI) (recently embraced by Warren Buffett) and Lennar (LEN). D.H. Horton builds more homes, but Lennar’s are more expensive, so their dollar volume is higher. Both companies are major components of homebuilder exchange-traded funds, including SPDR S&P Homebuilders ETF (XHB) and iShares U.S. Home Construction ETF (ITB), which of course afford diversified exposure to the industry.
Some serious money can be made buying, selling and leasing real estate directly but this can be an extremely time-consuming undertaking best left to professionals. For individuals seeking to leverage income and returns from real estate while they do something else for a living, such as practicing medicine, indirect methods make a lot more sense.
Dave S. Gilreath, CFP, is a founding principal and CIO of Sheaff Brock Investment Advisors, an investment firm for individual investors, and Innovative Portfolios®, an institutional money management firm. Based in Indianapolis, the firms manage assets of about $1.3 billion. The investments mentioned in this article may be held by those firms, Innovative Portfolios’ ETFs, affiliates or related persons. There may be a conflict of interest in that the parties may have a vested interest in these investments and the statements made about them.