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REITs and CEFs: The KISS Principal Applied to Real Estate
Real Estate investing is not nearly as legally complicated, financially burdensome, or time consuming as you might think. In fact, it is easy to add raw land, shopping centers, apartment complexes, and private homes to your portfolio without Brokers, Bankers, Attorneys, and a Rolodex full of maintenance professionals' phone numbers. Even better, you can blend your Real Estate investments into your security portfolio for ease of management, income monitoring, diversification analysis, etc. Without having mega millions to work with, or a line of credit that goes around the block, you can have positions in various forms of Real Estate (Commercial, Industrial, Residential) at the same time, and focus either on Growth Opportunities, Income Production, or a combination of the two.
If you thought that Real Estate was out of your investment reach because of limited funds, or minimal personal experience, you were selling yourself short. All of the basic types of Real Estate Investing are available through CEFs (Closed End Funds) and REITs (Real Estate Investment Trusts), and both can be purchased in the same manner as any common stock. And for me, this has always been their (CEFs and REITs) single most attractive feature! You can own a piece of the action without the big commitment of time and resources. You can take advantage of changes in the Real Estate Market Cycle in precisely the same manner as you can deal with the volatility and fluctuations in the Stock and Fixed Income Markets.
Real Estate CEFs and REITs are obviously safer investments than outright purchases of Shopping Centers and Apartment Complexes. They are also somewhat less risky than owning the common stock of individual Real Estate companies. The size of the numbers may be less exciting, but the net income and capital gains potential are comparable and the turnover rate much more impressive. Both methods (of participation in the Real Estate market) should be considered as you add to your investment portfolio... but to which Asset Allocation "bucket"? I've always included REITs and Real Estate CEFs in the Fixed Income bucket while the common stock of a plain vanilla Real Estate Company would properly fit within the Equity portion. When adding Equities of any kind to your portfolio, you should avoid the standard "Mob Popularity and Greed" model and select only S & P, B+ or better, rated stocks that pay dividends (regardless of size) and that are priced at least 20% below their 52 week high. After a huge rally in any market, I would be even more selective than that from a percentage standpoint, and I would buy about one-half the normal position to facilitate average cost reduction later. You must establish a reasonable profit-taking target on any investment. Real Estate is no exception. No matter what the investment, Virginia, the longer and stronger the rally, the steeper and faster the correction is likely to be.
On the Income side of the portfolio, make sure that you look at a lot of REITs and even more CEFs of various kinds to get a feel for the levels of income they produce. REITs must pay out a certain percentage of their earnings, but CEFs may not have the same restriction. I believe that either can be "leveraged", which simply means that management may choose to borrow some of the money that they invest. Leverage is not a four-letter word when used properly, and (in my opinion) it is more likely to help your results than it is to hurt them. It's always a good practice to stay within the normal income range, assuming that there is either a risk or a management reason for the highest and lowest yields, respectively. Be careful not to create a poorly diversified income portfolio. Bonds, Preferred Stocks, Mortgages, etc. deserve your attention as well and should be represented. Monthly income is available and more attractive than any other.
The major distinction between the two types of investing needs some re-emphasis. When purchasing stock in a Real Estate company (or any other company), your main objective should be to sell the stock for a reasonable profit as quickly as possible. You will then select some other stock and repeat the process. It is likely that you will return to the same companies over and over again, and you are the manager... any dividend income is gravy. When purchasing a REIT or a Real Estate CEF, you are depending on the managers of these entities to generate income and capital gains and to pass it on to you every month, recognizing that the actual amount may vary slightly over time. You have the bonus capability either of selling the REIT or CEF shares when they rise to an acceptable profit level (more gravy), or of buying more shares to increase your income level. The distinctions (benefits?) of this form of Real Estate Investing vs. ownership of the properties themselves should be clear as well.
No attorneys; no debt; no maintenance; no problem.
About the Author: Steve Selengut
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"