REITs are an awesome tool for creating a mini real estate portfolio without raising £000’s. Here’s why I like them in my financial independence portfolio.
Back up – what are REITs?
Prounounced “reet” (like a geordie saying hello), REITs are Real Estate Investment Trusts. It’s not just a clever name: they invest in real estate.
At their heart, they work more like a company than, say, a personal trust that you might leave in your will. Investors buy shares in the REIT, then the REIT uses this to put down a deposit on properties, basically crowdfunding the purchase (and sometimes development of) properties that most regular retail investors like me couldn’t ever afford to finance.
Most REITs have a portfolio of properties, and trade on the various stock markets or investment exchanges, like the Alternative Investment Market (AIM).
A REIT can specialise in any type of real estate, or diversify as it sees fit. For example, New River REIT mostly buys shopping centres. Warehouse REIT and Tritax Big Box REIT both buy warehouses and light industrial buildings. Supermarket REIT buys… you get the picture.
Most companies don’t actually own the buildings they’re in. Like a regular person, they rent. That Tesco around the corner? Probably a tenant. Amazon’s nearby warehouse and distribution hub? Almost certainly rented. So, who do they pay rent to? That’s right, the REITs are the landlords of the commercial world.
Fun fact for you: it’s pretty common for commercial tenant to take on a “full repairing and insuring” (FRI) lease. This means that, unlike renters in houses, the landlord doesn’t pick up the bill for most of the repairs that need doing. No need to fix blocked toilets at 4 a.m. for a commercial landlord!
You can also get residential REITs. These work the same way, but the tenants tend to be normal people or councils who are renting them for council housing.
If you’re bored and want more detail, there’s a summary of UK REITs by Deloitte that you can look into. It’s about 6 pages long.
Here’s also a video from a YouTube channel called Pensioncraft. Ramin explains this much more eloquently than I just did…
So, you can buy REITs. Why would I want to?
REITs pay dividends. In fact, unlike most shares that pay dividends, they literally have to. To qualify as a REIT, they have to distribute 90% of their tax-exempt property income. This means that owning shares in REITs is basically great for earning passive income. A typical REIT on the London Stock Exchange or Alternative Investment Market will pay a dividend of around 3-9%, depending on how well the stock is performing.
Oh, yes. Much like buying a house and renting it out, the buildings that the REIT owns can go up in value, too. This gets reported on a REITs balance sheet and should mean that the REIT share price increases along with it. I say “should” because markets aren’t that efficient and there’s a risk that a REIT either gets overlooked or overrated by the market. Ah, well.
REITs vs. Buy-To-Let
You could get into real estate to make money by becoming a landlord yourself. Of course you could. However, there are some advantages to using a REIT that might make you reconsider.
- You don’t need a big deposit pot. Instead of saving away £20k plus fees to put down a deposit on a buy-to-let property before you get any rental yield, with a REIT each share you buy will generate a dividend yield. You could start on a free trading platform with £1.
- You don’t pay for the conveyancer, builders etc… Technically, the REIT does use some of the investment money to pay for these things, but due to the scale of the business, the cost to you is dwarfed by the amount of income and the number of properties which the REIT owns.
- Concentration risk. If you own a rental property and it goes empty for two months, you’re losing income and paying a mortgage (probably). However, a REIT has to own at least 3 properties and might own hundreds, so one property going empty for a few months will only slightly reduce your dividends.
- Liquidity. Ideally, you don’t need to sell your rental property or your shares in REITs, as they’re providing you with passive income. However, life changes, times get hard, or you might simply need to rebalance a portfolio in retirement. Unlike a buy-to-let property, you can sell all or some of your shares in a REIT with a touch of a button, pretty much instantaneously during stock market trading hours.
ISAs
REITs can be held in an ISA. I’m currently rebalancing my ISA to have a generous 20% holding in a selection of REITs. This way, the dividend income from them is tax free. That’s right: tax-free rental income. Sweet.
You can’t do that with a buy-to-let!
ETFs
You can actually buy ETFs which include a whole basket of REITs. An example is this one from iShares (AKA BlackRock). There are others, of course, and I will hasten to add that this is not a recommendation – do your own research!
My point is that if you decide that REITs are for you but don’t know what you want to buy into, there’s the option to buy a big stack of REITs from around the world in simple, easy-to-buy ETFs. Convenience, practicality, diversification.
What I’m doing
You’ll see from my 2021 FIRE campaign plan that investing is going to be a key part of my strategy, and that I’m taking risks by removing bonds altogether.
Instead, I’m using REITs as one of my diversification options. Technically, investing in REITs is another equity investment and if the whole stock market suffers then my REITs will drop in value, too. However, the rental income from them isn’t dependent upon the share price, it’s based on receiving rents from the tenant, so I’m treating them like a real estate investment instead of a regular stock market investment. They’re not fixed income like a bond, but they’re not a bad approximation for my purposes, and I have to take risk somewhere if I want to achieve my goal within 10 years.
I’m specifically targeting UK logistics and warehouse REITs at the moment. At the time of writing, their are some bargains out there with a price:earnings ratio of less than 15, and a decent 5-7% dividend yield. I reckon that with Brexit adding strain to the logistics chain of big businesses, everyone switching to online shopping and so on, warehouses in the right locations are in short supply and will be in demand for the foreseeable future. However, just because I’m doing it, doesn’t mean that you should follow me: do your own research.
When I have achieved financial independence, I will probably want to rebalance my portfolio of assets to include more income-generating ones, like dividends shares and potentially bonds. If my REITs are still looking strong, I might be holding onto them for a long time!
I’ve thought about it and I’d like to know more…
Below is a list of UK REITs on the main market of the London Stock Exchange. This list was lovingly ripped from the LSE website, which might be worth a visit too.
