Small Group Meeting Q&A (9)

Small Group Meeting Q&A (9). Written on August 27, 2018

Question nine: What should people who buy REITs pay attention to? How do I know whether the REIT market will fall or rise?

Answer: The biggest risk for REITs is interest rates.

REIT companies all use high leverage to invest in real estate. AGNC's leverage ratio reaches 25 times. Other companies may be leveraged five times or 10 times. These companies all carry high debt, so interest expense is a major cost for them. When interest rates rise, the cost pressure on these companies becomes relatively large.

In addition, investing is about returns. For these securitized real estate companies, the return is equivalent to their yield, and there is usually very little capital gain. Whether these yields can satisfy your return expectations is the question. I see many companies with yields roughly under 10%. If that is the case, it is better to invest directly in U.S. indexes such as SPY and QQQ to obtain higher long-term returns.

Some people are attracted to the dividends from these securitized real estate investments, but dividends are equivalent to short-term profit. In the United States, dividends are included in personal income tax, which makes this a very uneconomical investment. We have discussed before that if you are taxed on short-term income every year, in the long run your final total assets may be only one-third of those of someone who bought the index and held it long term.