Why I don’t like REITs?
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.
| Accounts | ROR | Yield |
|---|---|---|
| Computershare | 12.01 | 5.92 |
| Portfolio | 12.45 | 2.36 |
| RBC | 9.22 | 16.41 |
| RBC-S | 8.10 | 5.01 |
| RRSP | 16.31 | 0.89 |
| RRSP-S | 11.26 | 1.03 |
| TFSA | 12.41 | 0.85 |
| TFSA-S | 14.36 | 2.43 |
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.
Great breakdown, thanks. In my very early days, I also got sucked into those sweet REIT distributions. I don’t hold REITs anymore, but am sometimes still tempted so it’s great to see a detailed rationale as to why they don’t fit my thesis.
Thanks for the comment. It’s an easy to understand investment when you start dividend investing but there lies the trap for long term investing :)
Good article! It appears there are only 3 Cdn REITS which pass the 10×10
criteria.
Ticker Company Div Growth Streak Yrs 10-Yr Avg DGR 10-Yr CAGR TR
GRT-UN Granite REIT 11 14.3% 18.3%
NET-UN Canadian Net REIT 10 10.6% 17.5%
IIP-UN InterRent REIT 10 10.6% 24.3%
Indeed but I don’t track NET.UN. It’s way too small. I know it’s on people’s radar but it’s barely worth over $100M in market cap.
It makes it a “MICRO CAP” stock which is risky in trading patterns.
I would say you can invest in it, but I would not classify it as a REIT in the sense of big REITs. It’s more like an IPO growth stock.
Dividend Earner,
I found your REIT analysis an interesting read. I have read multiple studies comparing REIT performance to overall US stock sector performance. These show that over time, REITs have done well in terms of overall return. Below is one SA article that does a good job of showing relative REIT performance over time. I hope you can open the link. If not, the article is called “The Data Is In: REITs Outperform In The Long Term” by Austin Rogers. As a retiree I am comfortable holding 5-10% of my portfolio in high quality REITs as a source of steady income.
https://seekingalpha.com/article/4390413-data-is-in-reits-outperform-in-long-term?source=email_author_rta:read_now&utm_medium=email&utm_source=seeking_alpha&mail_subject=cashflow-capitalist-the-data-is-in-reits-outperform-in-the-long-term&utm_campaign=rta-author-article&utm_content=link-1
The article you share is fair I assume as it relates to the US market. I cannot comment on US REITs.
On the Canadian front, I stand by my thinking. A good number of REITs are actually the giant grocery and retail companies spinning off that part of their business anyways.
You are correct; the analysis was US REIT focused. Are you aware of a similar analysis for Cnd REITs? I’d like to see it if there is one.
We currently own two Cnd REITs in our RRIF, namely Choice Properties (CHP) and Dream Industrial (DIR). They haven’t been around for 10 years yet, so I had to look at an 8-1/2 year period to estimate annual ROR for them. For CHP it is 7.8% and for DIR it is 9.9%. It appears that the TSE had an annual ROR of 8.0% over the same period of time. I don’t see them being disadvantaged in this regard.
I just view REITs as one part of an overall balanced portfolio. I try to own ones that have a 4% to 6% div yield and a market cap of $3+B. This seems like a sweet spot to me.
I am not aware of REIT analysis like the one you shared.
I had been dripping starting in 2010 and transfered my drips in a brokerage account in 2017. I sold HR and Riocan when I realized the yield on cost of my banks and insurance companies were surpassing that of the REITs.
I agree – I’m in the “Income needed” of my retirement phase and I examined, then discarded, REITs. Although they look like good income the value of the shares does not even keep up with inflation in some cases.
I went with 3 ETF’s in my main income portfolio: XEI (50%), HDIV (25%), and HMAX (25%). I am starting to regret buying HMAX and wished I had split that 25% with HCAL + HFIN. At any rate, I’ll take a loss on it next tax year and shuffle things around.
Great analysis. As relates to Canadian REITs, still an excellent investment to keep in a retirement portfolio. Just to mention no one type of investment is holy grail.
Eric,
I don’t own any REITs. Several years ago, my financial advisor asked me for my take on them when I pointed out that REITs were missing from my portfolio.
“You own a house, don’t you?”
“Yes.”
“Are you happy with the ROI?”
“I turned a $1,500 down payment on my first condo in Toronto in 1973 into a detached home in the GTA worth seven figures.”
“So, you turned $1,500 into a million and had a place to live all these years. Why do you need a REIT?”
“I don’t.”
Case closed.
Michael.
Thanks for sharing your personal rational about why you avoid REIT investments. I think your criteria for picking stocks that will provide you with a worry free income stream in your future retirement is great. I believe good diversification is also important. REITs can provide one component of diversification, and there are REITs that offer a broad range of investment focuses (for example; net lease, health care, office, data center, cell tower, storage, casino, cannabis, apartment, hotel, SF housing, infrastructure and others). The reply “Rick” already provided shows that over a long period of time US based REITs have done very well overall. I like his criteria for helping pick potential REIT investments as well. There are also studies that show REITs do poorly in a rising interest rate environment, which is what we’ve been in recently. They are starting to come around now as the rate increases seem to be likely over due the decreasing rate of inflation. As a retiree, I use US REITs primarily to help with income flow.
Thanks Rick.
There may very well be a difference between REITs in Canada and the US. You highlight US and in my case it was all about the Canadian REITs and I wrote the post much before the interest rate increases. So my comments and rational have nothing to do with the interest rate increases although it does show that REITs will be cyclical unfortunately.
I probably will not look or review the US REITs but I always read good things about Realty Income.
On the diversification comment, I feel very diversified without REITs … so we will need to agree to disagree on diversification :) To date, I have not seen a single real world example of diversification during the accumulation years as opposed to the decumulation which will have different factors at play.