When it comes to investment returns, real estate has historically been a great option. Many people have achieved great wealth by investing in real estate. Leverage can make it possible to control assets that are worth much more than any initial cash outlay. Borrowing money for real estate is not without risk, but for those who can make it work, the returns can be astronomical. Those who own rental property control the asset while other people build equity for them by paying down their loans through rental payments. In the best case scenario, rents exceed the cost of carrying the asset, which can provide a great deal of cash flow in addition to the increased equity that builds over time.
However, owning rental property outright is not for everyone. There can be hassles that come with owning property. Renters might not pay, and this can be catastrophic for a property owner who holds only one property. Also, there can be the possibility of a 2 am call to fix a leaky toilet (although I’ve had owners of rental property swear they’ve never received such a call in reality). This is where REITs, or real estate investment trusts come into play. They allow for investors to put their money toward a diversified real estate portfolio without actually having to deal with securing renters or dealing with people at all.
Vanguard Real Estate ETF
REITs allow investors to own rental properties in a variety of sectors of the economy. There are REITs that invest in commercial properties that hold buildings in the health care or hospitality industries. Others invest in residential properties.
One fund that allows investors to invest across the REIT sector is Vanguard Real Estate ETF (NYSEARCA:VNQ). This fund holds 164 individual REIT stocks, and it provides a decent yields for investors. As of July 14, 2023, the yield for VNQ is 4.38%. Over the past 12 months, the S&P 500 has done quite well after a large drop early in 2022. However, VNQ has seen its share price drop by nearly 5% over the same period.
This drop is largely tied to interest rates, which have increased over the past year. As rates rise, those looking for income can look elsewhere for safer options. Additionally, it becomes more expensive to borrow money, including on mortgages, a debt which many real estate companies will hold.
Over the past ten years, there has been little growth in the share price of VNQ shares. Indeed, according to Seeking Alpha’s 10-year price graph, the fund has only seen its share price grow by 18%, a CAGR of less than 2%. The dividend yield improves this total return, but it is still lower than the return of many other stocks and funds over the same period.
The REITs that make up VNQ are legally required to pay out 90% of their taxable income to shareholders in the form of dividends (as are all REITs). This leads to dividend payments that are frequently in excess of the broader market as a whole. However, it comes with a caveat. These are not qualified dividends. Therefore, the dividends are not taxed at capital gains levels. Rather, they are treated as ordinary income, which is taxed at a taxpayers’ marginal rate. At higher income levels, this can make a major difference in the amount of the dividend income an investor will actually realize. Many investors would do better to hold REITs and REIT funds in tax-advantaged accounts, although individuals should check with their tax professional to assess the proper strategy for each person or household.
Those who are looking to earn a diverse income stream from real estate without giving much thought into the process might do well with VNQ. However, there might be better options for those who want to do a bit more research.
Another Option
Looking for REITs with strong histories and strong dividend income can actually provide more growth and more dividend income. One of the most popular REITs on the market is Realty Income Corp. (O). This company is also known as the monthly dividend company because it pays out a dividend on or around the middle of each month. The yield is currently 5.04% after recent decreases in the share price.
Realty Income has grown its dividend 121 times since it first hit the market in 1994. Effectively, it raises the dividend every quarter. Sometimes, these raises are small, coming in at just $0.0005 per share per month. At other times, the raises can be more substantial. However, it’s a growing income stream regardless.
The price of O has increased at more than double the rate of VNQ over the past ten years (an increase of 38.07%), although the latter has outperformed O over the past year (a decrease of 4.48% for VNQ vs. a drop of 11.15% for O). Realty Income is just one option for a growing dividend stream that has a higher yield with a better long-term price growth profile. While past performance is no guarantee of current and future results, it is at least somewhat instructive.
Conclusion
Those who have the time to research REITs could search the holdings list of VNQ and choose a few REITs that have higher yields with strong financials to possible outperform the fund. While VNQ is not a bad holding, those who do some due diligence could weed out some of the lower performing stocks in this fund and purchase a few REITs outright to diversify while bringing in a solid income at the same time. With the advent of no-cost trading with many online brokerages, the relatively high expense that used to come with purchasing a few shares here and there is no longer an issue.
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