Why I Don’t Have REITs

Why I don’t like REITs?

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This is a common question I get as investors look at my portfolio and as we discuss retirement income.

Should I invest in REITs is the question you may be asking yourself. Read on to discover how I concluded I will not invest in REITs.

Any sound dividend investing strategy would not include REITs (Canadian REITs). REITs check very few checkboxes on a dividend investing guide during the accumulation years.

The Early Days With REITs

When I started my dividend portfolio in 2009, I invested in REITs (and income trusts) as they had some of the highest yields next to BCE. My goal when I started was to retire with dividends, so I went all in with high-yield stocks …

Fast forward a couple of years, and I learned more about dividend investing. It turns out that REITs and Income Trusts were a mistake from the angle of portfolio growth. Sure, I was getting a good income, but it had little dividend growth, and the price of the investments was mostly going sideways.

In short, my growth corresponded to the yield of approximately 5% compounded with DRIP when it was enough to re-invest. It was better than leaving your money at the bank, but not the best. Sure, REITs hold real estate for regular revenue, and that’s a model we all like, but increases can be limited through regulation.

So you earn 5%. What’s wrong with that? Well, with the Rule of 72, it takes 14.4 years to double your money. Wow, I don’t want to wait that long, not to mention that stock market returns have been around 8% historically. Should I do index investing?

That’s when I put together my Portfolio Tracker. The purpose was to accomplish these two goals:

• Compare my portfolio returns to index investing. I will index during the growth year if I cannot beat it.
• Correctly calculate the annual rate of return of my portfolio.

Having the data has made me a better investor. Sometimes, simple improvements lift your investment return over time by 1% or 2%. It’s not always about the home runs.

The Eureka Moment

After doing investing research and realizing that the Canadian Dividend Aristocrats requirements were not strong enough, I found a research document from an investment firm focused on dividend stocks with ten years of consecutive dividend growth and a 10% compounded annual growth rate (CAGR).

That resonated with me, and I decided to call them Dividend Ambassadors because of the lack of other names. You see, it’s not just about dividend increases anymore.

As you can imagine, there are not many REITs with a 10% dividend growth rate over ten years.

A future metric I started using is the Chowder Score, which helps you understand the potential total growth of a company over time.

Again, not many pass the threshold I want during the accumulation years as my minimum is 10%.

REIT Business Model Not For Growth

Do you know and understand the business model? What are the benefits and drawbacks?

I consider REITs a tollbooth investment, which I like, but the business growth is limited.

The business growth comes from:

• Increase rent, which is difficult as big businesses will sign long-term contracts, and you can’t choose the rent increase for residential tenants unless they move out.
• Reducing your vacancy rate will increase your income, but generally speaking, there isn’t a lot of vacancy in general, so that’s also hard to do.
• New properties are available to generate income. That’s a slow process. You need a strong pipeline and capital plan to keep the pipeline going year after year for consistent growth.
• Acquisition leads to growth by increasing revenue and consolidating operations and expenses. It’s not easy to do year after year.

As you can see, it’s not easy to create revenue growth. The smaller the REIT is, the easier it can be, but then it’s more of a speculative growth investment than an income play, in my opinion.

Total Return Expectations

I am a dividend investor, and I want to retire from my dividend income, but getting to the end goal requires a good portfolio size.

Retirement freedom is all about the size of your portfolio, which is why you must know your rate of return. The income from your portfolio is simply a variable that you apply to your overall portfolio based on the investment you choose to hold. Be it 3%, 4% or 5% yield.

Since total return is the combination of your portfolio appreciation and dividend income re-invested, if you only focus on the dividend income, you might have to save more money and take more time to reach your goals.

Here is the ROR for my accounts – I try to update it monthly. At 14%, it takes five years to double, and at 7%, it takes ten years. Would you want to shave five years of work and savings? Well, you might have to choose a lower yield to get 14% annual ROR.

As you can see, during the accumulation years, REITs aren’t really in the dividend growth category.

What About Portfolio Diversification?

Do you want to be diversified? Then, invest in the entire world stock market, and you will be diversified. That’s overkill …

How about diversification across the 11 sectors? I don’t think it’s critical to be fully diversified across the 11 sectors. I think you want to be exposed to five or six sectors, but you don’t need all of them to be fully diversified.

In the end, diversification isn’t about how spread around your money by sector or industry but about the confidence you have in the businesses you are investing.

Here is what my diversification looks like by sectors and industries.

Ask yourself what the maximum you want in a company. Is it 5%, or 10%, or 20%? If that’s the max, what’s an average position and why is it that number?

Once you have your number, must it include REITs to be diversified? And if so, why? What’s the reason, and does it come from a position of fear or greed? Is it a defensive strategy or an offensive strategy?

While REITs can be seen as defensive, I am not sure they are the best defensive option for diversification.

Retired & Seeking Income

The accumulation years are over and it’s time to live from the income of your portfolio.

The goal is to beat inflation and have as much income as possible. Not all investments have to beat inflation, but overall, you need your portfolio to beat inflation.

Where do REITs fit in the income and inflation category? Again, they don’t pass the inflation test, but some of them pass the income test.

What’s the income test? It’s a tough one, and we need to review a previous Q&A on the ratio of high-yield investments. The higher the yield, the lower the dividend growth.

In the table below, “Normal Yield” should have a decent dividend growth with banks and utilities. You should be able to get 6%. With “High-Yield” you might have some with telecoms and other uniquely positioned investments.

Aside from that, you don’t need growth, but you need stability. Many REITs dropped their distribution during the pandemic.

	Portfolio Ratio	Amount	Assumed Yield	Annual Income
Risky Yield	10%	$140,000	7.0%	$9,800
High Yield	45%	$630,000	5.5%	$34,650
Normal Yield	45%	$630,000	4.0%	$25,200
Low Yield	0%	$0	1.5%	$0
		$1,400,000	4.98%	$69,650

Better Alternative To REITs

I have to admit that after looking into covered call ETFs, I don’t see a reason to invest in REITs.

Buy BCE instead of a REIT, for example, and then add a covered call ETF covering various investments.

Here is what a retirement portfolio composition looks like for a reader. There are not many REITs, as you can see, and he mentioned moving away completely.

• 1.85% – REITS
• 2.41% – Fixed Income (GICs)
• 5.01% – Split Shares
• 5.41% – Closed End Income Funds
• 7.28% – Preferred Shares
• 38.89% – Covered Call ETFs
• 39.16% – Stocks

What About REITs During a Recession?

If you look at the REITs these days (July 2022), they are all depressed and trading near or at the 52-week lows.

It’s not great for a portfolio, but it does push the yield high.

Here is the issue with that. They can drop the distribution, and then your yield goes down again. You are back to square one. It happened during the pandemic crash.

The REIT Aristocrats don’t have a yield significantly higher than a decent covered call ETF either.

Overall – REITs Aren’t Appealing

All in all, you may be tempted by the yield and the simple business model, but over a long investing journey, REITs lack appreciation and dividend growth. They also aren’t any safer than other investments.