The Pros and Cons of Adding Real Estate Investments to Your Portfolio

Once dominated by large players such as pension funds and insurance companies, the globalization of real estate investing has spurred an increase in real estate allocations throughout investment portfolios. According to Nareit, approximately 150 million Americans own Real Estate Investment Trusts (REITs), through retirement accounts and other investment funds. Owning real estate is appealing to investors for its potential to reliably provide passive income and diversify their portfolios, though owning REITs of course has its risks. Consider these points when deciding whether to start investing in REITs.

The Pros and Cons of Equity REITs

The most commonly held REIT is the equity REIT, which is a company that acquires and oversees residential, commercial and industrial real estate. Although a REIT can specialize in a particular investment property type, its portfolio typically spans a diverse range of assets, including shopping malls, cell towers, medical clinics, residential buildings and forest land. The primary source of revenue for equity REITs is rental income.

Pro: Potential for Higher Earnings

Federal tax code requires a qualified REIT to distribute a minimum of 90% of its taxable income annually as dividends to its shareholders. In contrast to other companies, REITs typically avoid holding back earnings, which often results in the potential for higher yields compared to other investment options, particularly in times of low interest rates and market volatility. Investors can purchase shares in individual REITs, similar to investing in publicly traded companies, or buy through mutual funds and exchange-traded funds (ETFs).

Con: Interest Rate Sensitivity

The prices of equity REIT shares can fluctuate with the movement of interest rates as companies rely on debt to acquire properties and real estate values are affected by interest rates. As interest rates rise, the dividends from REITs may become less attractive compared to bonds — known for their stability — that provide similar yields.

Pro: Increased Portfolio Diversification

REITs stand out in the stock market as an asset class with features similar to traditional stocks and bonds. Real estate allocation in your portfolio not only promotes asset diversification but also enhances your overall asset allocation strategy. When determining how much of your portfolio should be in real estate, it’s important to remember that while this diversification and allocation can be effective risk management tools, they cannot guarantee profits and are not immune to losses. 

Con: Real Estate Has Risks, Too

Investing in real estate comes with inherent risks that investors should be aware of:

• Economic downturns at all levels, from national to local.
• Tenants failing to fulfill their lease obligations.
• A surplus of rental space or a decrease in demand for properties.
• Poor management of properties.
• Rising costs like energy prices, real estate taxes and the expenses to stay in compliance with local regulations

Expert Advice, Tailored to Your Needs

When it comes to creating and investment portfolio, there’s no one-size-fits-all solution.  A Farm Bureau financial advisor can help you effectively manage risk within your portfolio while working with you to reach your goals.