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 system, private 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.
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.
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