Alternative Investments – Real Estate

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Alternative Investments can provide lucrative returns that are unavailable by investing in the stock or bond market. In earlier posts, we discussed alternative investments in farmland, rooftop solar systemprivate equity, and collectibles. In this article we discuss investing in one of the most popular forms of alternative investment – Real Estate. Note that investing in farmland is also a form of real estate investing, but I figured that farmland had a special case which deserved its own post.

As mentioned, investing in real estate is one of the most popular forms of investing as it is easy to understand and provides one of the most basic needs of human survivability – shelter. There are multiple options for investing in real estate: one can invest in a piece of land and hold it for capital gains, or invest in a house/condo/multi-family units and rent it out to generate cash flow while holding the property for capital gains or purchase shares in a real estate investment trust (REIT) company.

Alternative Investments – Real Estate

Investing in a property is usually capital intensive, as a downpayment is usually necessary. However, due to the availability and popularity, investing in real estate investment trusts (REITs) is a breeze with companies easily available to trade on the stock exchanges. Investing via REITs provides some advantages as well – in that you can compare one business against another and pick to choose the best one. Also, when buying shares in REITs, it is easy to liquidate funds which may not be possible with owning your own property. A few weeks ago, Robert Baillieul guest posted on this blog on how to invest and collect monthly rents without becoming a landlord.

This is not to say, buying a piece of property and renting it out to generate cash flow won’t work. But this comes with its own problems. One has to be good at picking the right properties and have the time to manage it. Alternatively, you can hire property managers who take care of the day-to-day issues and take a small cut from the collected rents. This works very well in the case where the property you own is in a different city.  Comparing rental property investing and REIT investing are not very straight-forward though and each method comes with its own advantages and disadvantages. This post from FI Fighter elaborates his take on the comparison.

REIT Investing – Which One to Pick?

Investing in REITs isn’t simple anymore. Years ago, there were only a handful of companies listed on the public markets and invested in selected space. These days, it is not uncommon to find companies specializing in very specific types of REITs. One can buy REITs focused in apartment buildings, shopping malls, hospitals and nursing care centers, retail locations, mortgage debt, technology-space data centers, office space, industrial-focused, farmland etc.

  • Apartment and Residential REITs: invests exclusively in apartment buildings or residential buildings.
  • Retail REITs: Retail locations are the focus of this REIT and some companies include Realty Income Corp (O), RioCan REIT (REI.UN.TO).
  • Mall REITs: These REITs invest in shopping malls. Some of the largest companies in this space include Simon Property Group (SPG), General Growth Properties (GGP). Read more about mall REITs here.
  • Healthcare REITs: Healthcare REITs invest in a variety of health properties including senior housing, hospitals, skilled nursing facilities, medical office buildings etc. Some of the largest companies in this space are HCP Inc (HCP), Ventas (VTR), Healthcare REIT (HCN), Omega Healthcare (OHI) etc. Read more about Healthcare REIT here.
  • Mortgage REITs: This investment focuses on the debt rather than the equity.
  • Data Center REITs: This is a specialty REIT that provides exposure to the real estate aspect of tech companies and their data centers. Digital Realty (DLR) and these companies provide with some exposure.
  • Office REITs: Companies focused on office space such as Dream Office REIT (D.UN.TO) or other such companies.
  • Industrial REITs: Industrial REIT focus on industrial space and warehouses, which has become a new special sub-sector play of late.
  • Farmland REITs: Invest exclusively in farmland. I am aware of only two companies in this space – Farmland Partners Inc (FPI) and Gladstone Land Corp (LAND).

Investing in any of the listed REITs will require the investor to understand how to evaluate the companies and also understand the space well. Due to the nature of real estate investing, classic evaluation techniques such as Price-to-Earnings or payout ratios cannot be used exclusively to look at how they are valued. The evaluation method is slightly different when it comes to REITs and investors need to look at FFO (funds from operations) or AFFO (Adjusted funds from operations), and the equivalent to check is P/FFO or P/AFFO ratios instead. There is plenty of literature online, so I will not go into the details here. In addition, evaluation of specific REITs come with its own risks, so understanding the business is extremely important. For e.g, one cannot simply state that farmland is the best investment as there is no building to manage – its just a piece of land and all it takes is a farmer (labor) and some water to make it productive. This kind of evaluation is dangerous – What happens if the soil is not productive and over farmed? What happens, if there is no infrastructure support closeby? What happens if there is severe drought in the region? This is just one specific example, and likewise, each REIT comes with its own risks and rewards – so think and evaluate before jumping in.

Conclusion

Investing in real estate is one of the most popular forms of investing. It is easy to understand and can be a lucrative business opportunity for people looking to go financially independent. However, being easy to understand does not mean it is easy to do – one has to have a good eye for looking and acting on the right opportunities. Investing in real estate can come either in the form of investing in a rental property, flipping a property (short or long term) or buying a REIT on the stock market. While the REIT stocks allow everyday investors to invest a small amount of money to become partial property owners, each REIT comes with its own unique risks and rewards. Understanding the space is paramount before picking a subsector in the REIT space.

Further Reading

Some bloggers and authors that I follow closely write a great deal about investing in real estate. Check out their blogs/pages and follow them if you are interested in further reading and understanding the space.

  • FI Fighter – A savvy real estate investor based in California who shares his success and struggles on  regular basis. He owns a lot of properties across the US and uses property managers to take of the day-to-day operations. He shares detailed accounts of cash flow statements for each of his property – definitely one of the best resources out there.
  • No Nonsense Landlord – Similar to the one above, shares a lot of details of real estate investing including cash flow statements. The blogger is based in Minnesota.
  • Brad Thomas – One of the best resources for REIT investing and evaluating companies, writes regularly on Seeking Alpha.

Full Disclosure: Long O, OHI, REI.UN.TO. My full list of holdings is available here.

Image Credit: Freedigitalphotos.net/Vichaya Kiatying-Angsulee

11 thoughts on “Alternative Investments – Real Estate

  1. R2R,

    As you know, this is my preferred investment vehicle. I like finding apartment syndicates who purchase one or more apartment complexes and then sell equity shares to investors. Operating profits are split between the investors and managers on a quarterly basis and 3-5 years out when the property is sold or refinanced, both parties share in the equity upside. This provides cash flow today and potential equity payout in the future. Since commercial property is value based on net operating income (NOI) and the capitalization rate, a well management property can increase in value simply by increasing revenue and decreasing costs.

    Regards,

    Deets

    • Deets,
      I remember your article – and its great to see the amount of returns you are getting out of it. Thats a nice alternative investment and Im sure a lot of folks arent aware of that method.

      Best
      R2R

  2. R2R,

    Thanks for the mention! Real estate can definitely be lucrative and it is an investment vehicle that many have used to get to financial freedom; same with stocks.

    In general, I’m a huge fan of diversification because I see the merits of all these types of investments: stocks, real estate, REITs. Although they all have their own unique characteristics, as investors, there’s nothing that says we have to pick and choose just one form of investment. If you want to, and many do, invest in all of them.

    Just yesterday, I had a nice conversation with an avid stock investor, and one thing he mentioned to be was: “I wish the stock market was more inefficient, like real estate. When you tell me about buying pocket listings for well below market price, or doing a light renovation and forcing appreciation in just a matter of months, it really piques my interest to learn more.”

    That’s a wonderfully open perspective to have and no doubt this guy will benefit because of it. While many focus on the clogged toilets, hassles, and other headaches, this guy can see passed all that and instead chooses to focus on the BIG picture. Then, when you start diving into things like cash out refis, HELOCs (wonderful tax-free ways to pull out enormous equity build up), 1031 exchanges, etc., you really start to figure out why and how so many people succeed so brilliantly with real estate investing.

    Cheers!

    • That is a great way of looking at things. Thanks for sharing and good on your friend for keeping an open mind. Real estate is something that has always piqued my interest and last year when we were buying our home looked a quite a few duplexes to see if we can buy something where we could live and rent part out as well…Unfortunately, that didnt work out, even though we are really happy with what we have now.

      Maybe sometime in the future, if theres a correction in the Canadian housing market, I can take the plunge into real estate, but for now, I watch from the sidelines.

      cheers
      R2R

  3. I’m not too big on physical real estate investing as I like my passive income to be as passive as possible. When you deal with rental properties, you have to deal with people, work your way through regulations and bureaucracy, and do all the stuff that I’m trying to get AWAY from in my quest for financial freedom and early retirement. If I ever owned property, it would be one of those 4-unit houses and I would live in one of the units. It would also be really the only way I’d be interested in home ownership, as I’ve always seen owning a home as a burden of responsibility rather than a vehicle of freedom (I feel the same about car ownership).

    Plus, there’s risk. What if your rental property catches fire? You can laugh, but stuff like that is a serious risk. You don’t have that with a stock portfolio.

    I love REITs, however. I know that there’s TECHNICALLY a difference, but to me it’s no different than stocks . Realty Income is another stock in my portfolio, not some alternative investment. That’s how I see it.

    Sincerely,
    ARB–Angry Retail Banker

    • Some great points raised, ARB…esp about the physical risks such as fires. Of course, investing in stocks comes with its own risks – and you have to trust the management to do a good and honest job and not cook books to appear better than they are. But I see what you are getting at. Investing in real estate physically sure does come with its own challenges and isnt for everyone – Like you, I prefer my investments passive. I have entertained the idea of landlording in the past, and Im sure I will look into it in the future.

      Again, I am in the same boat as you – that investing in REITs even though is technically different, its really no different than stocks and I treat it in the same way in my investment portfolio.

      Thanks for stopping by and sharing some insightful thoughts.
      Hope you are having a good wknd.
      R2R

      ps: Btw, I tried leaving comments on your blog – but it doesnt seem to be working.

  4. R2R, I am very much with you on loving REITs as alternatives to real estate ownership. Although unlike you I don’t think I would want to be a landlord at any point in the future. Like ARB, I want to keep it passive! And certainly tax free within my TFSA. I’v a feeling over time I’ll be loading it more with REITs and effectively doing ‘transfers in kind’ into non-registered accounts for my TD, BNS and RY holdings.

    Thanks for the article 🙂

    • I really like the idea of building a great REIT portfolio in a TFSA, but real estate investing increases the cash flow by a huge amount, which is achievable by stock/reit investing. Currently, I do not have the resources for investing in real estate, but something that I might consider in the future.

      Best wishes
      R2R

  5. I have been investing in apartment and residential properties using REITS and this is the best thing I have decided for years. People with less capital can invest in properties within their range.

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