Want to maximize passive income while preserving your capital, and your sanity? Invest in REITs and reap the many advantages of Real Estate Investing without all the hassle!
What’s a REIT?
Don’t let big words and acronyms scare you. REITs are a very simple concept. Here’s my naive definition:
REITs are companies that invest in a variety of Real Estate and distribute a lot of dividends for its shareholders.
It’s not very official looking but it’s quite easy to understand, right? Let’s dissect it.
Invests in Real Estate
To classify as a Real Estate Investment Trust, the primary income streams of the company must come from Real Estate.
Think rents and interest on mortgages financing real properties.
At least 75% of its assets need to be in real estate and at least 75% of its gross income must come from real estate.
So if a company is classified in REITs, you can rest assure they are heavily invested in Real Estate and so will you, if you buy their stock.
Distributes a lot of dividends
How much? What about 90% of their taxable earnings?
While most companies keep their dividend payout – the amount of dividend paid in relation to the net income – at around 30% to 60%, REITs are required to pay almost all its net income as dividends.
That’s why the yield on REITs stocks is higher than dividend stocks because the companies pay much more in dividends.
Why would a company become a REIT?
REITs are exempt from corporate tax.
Sounds pretty good, right?
Because they are not taxed at the corporate level, distributions are paid in an individual investor level, generally in the form of ordinary income tax.
While ordinary income tax is something investors try to run away from, REITs are considered very tax effective, since they avoid double taxation.
Most companies have to pay corporate tax (35%) over income, and then investors pay long-term capital gains over the dividends. For REITs, there’s no 35% tax at the corporate level, but a possible higher taxation at the individual level.
It’s a factor to be considered while planning your investment strategy. When combined with proper tax planning can produce even better results.
Why are REITs good for investors?
REITs are really an incentive program created by the government in the 60’s so companies can keep developing the real estate market and giving a chance to investors to participate in the profits in a very material way.
As you can see above, the rules dictate that the company must invest heavily in Real Estate and distribute 90% of income to investors. In exchange, they get to pay no corporate taxes.
What you get is great passive income in a stable and diversified asset class.
Imagine you had a share in several 300-unit apartment buildings, High-rise office spaces, 20 different malls, and a couple hotels?
That’s the kind of diversification and access to large real estate that it’s hard to come by with other investment options.
When you have your passive income tied to all these different real estate options, you get a great deal of stability and peace of mind, without compromising in passivity.
For those solely allocated to dividend equities, adding Real Estate is a sure way to get a better handle over the swings of the stock market.
For those solely in Real Estate, adding this kind of diversification will also make things more stable than a single local market or single rental class.
Invest in REITs
My hope is that by now you have a good understanding of what REITs are and how adding them can maximize your passive income.
Nobody knows your goals and your portfolio like you, so armed with the knowledge of how REITs can maximize your passive income, you’ll get a much better chance to shape your financial freedom the way you want it!