Why I don’t like REITs?
Should I invest in REITs is the question you may be asking yourself. Read on to find out how I concluded I will not invest in REITs.
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 yield 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 later and I learned a few more things 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 side ways.
In short, my growth was a yield of 5% approximately and compounded with DRIP when it was enough to re-invest. It was better than leaving your money at the bank, but not the best.
So you earn 5%, what 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 the stock market returns are 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. If I cannot beat it, I will index during the growth year.
- Properly calculate the annual rate of return of my portfolio.
Having the data has made me a better investor. In fact, sometimes you do simple improvements that lifts your 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 that focused on dividend stocks with 10 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 for lack of other names. You see, it’s not just about dividend increases anymore, so no more companies making it on the aristocrat list after a one cent increase.
As you can imagine, there are not many REITs with a 10% dividend growth rate over 10 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. My minimum is 10%.
REIT Business Model Not For Growth
Do you really know and understand the business model? The benefits and drawbacks?
I consider REITs a tollbooth investment, which I really like, but the business growth is very 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 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 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 a consistent growth.
- Acquisition leads to growth by increasing revenue and consolidating operations and expenses. Not easy to do year after year.
As you can see, it’s not easy to just 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 it’s really critical that you 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 5 years to double and at 7%, it takes 10 years. Would you want to shave 5 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 really diversified? Then invest in the entire world stock markets, you will be diversified … Ok. That’s overkill …
How about diverification 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, does it have to 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 really 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.
Better Alternative To REITs
I have to admit that after looking into covered call ETFs, I really 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. Not much 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), you can see they are all depressed and trading near or at the 52-week lows.
Not great for a portfolio but it does push the yield really 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 pandamic crash.
The REIT Aristocrats don’t have a yield that is significantly higher than a decent covered call ETF either.
|ZWB||BMO Covered Call Canadian Banks ETF||Banks||Covered Calls|
|HCAL||Hamilton Enhanced Canadian Bank ETF||Banks||-|
|CIC||CI CanBanc Income ETF||Banks||Covered Calls|
|HCA||Hamilton Canadian Bank Mean Reversion Index ETF||Banks||-|
|RBNK||RBC Canadian Bank Yield Index ETF||Banks||-|
|ZEB||BMO EQUAL WEIGHT BANKS INDEX ETF||Banks||-|
|HEWB||Horizons Equal Weight Canada Banks Index ETF||Banks||-|
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, dividend growth, and aren’t any safer than other investments.