The real estate market is an interesting one. The economic environment can have expected and unexpected impacts on real estate, as we found out during the coronavirus pandemic.
The resulting recessionary pressure and impact on occupancy levels had massive — and somewhat surprising — effects on real estate properties and real estate stocks. And as a result, real estate companies, real estate stocks, and real estate investment trusts (REITs) are now getting a lot of attention.
Investors can develop the bad habit of getting caught up in trends and fads when looking for ways to quickly boost cash flow. But if you are looking for more stable investment opportunities with real estate stocks, it’s a good idea to step back and look under the hood — or in this case, the ticker.
In this article, we’ll do just that. First, we’ll compare buying real estate property versus real estate stocks. Then, we’ll explain the difference between real estate stocks and REITs. And finally, we’ll examine what to look for when considering an investment in real estate stocks.
Buying Real Estate Property vs. Buying Real Estate Stocks
Investing in real estate property is typically much less volatile than investing in the stock market.
While investing in an actual real estate property can be an attractive option, many investors choose instead to invest in real estate companies through stocks and REITs. They do this for several reasons: higher liquidity, lower maintenance, lower entry cost, and diversification.
Liquidity refers to how fast you can sell an investment without substantially impacting your gain or loss on that investment.
A major benefit of real estate stocks is that they are much more liquid. It’s generally far easier to buy and sell investment instruments than it is to buy, manage, and sell the actual property itself.
However, if you need to sell property in order to access your money in a buyer’s market, you might have to lower the price to a painfully low point.
Investors don’t often buy companies, but shares of companies. Why? Because owning part of a business is much easier than owning and running the whole business.
Let’s face it. Owning property takes hard hands-on work. And sure, you can hire a property manager to deal with clogged pipes on a Sunday, but managing the property requires effort and oversight.
Buying real estate stocks instead of the real estate property means you’re in the game, but you don’t have to show up for work every day.
The amount required to buy a real estate stock is considerably less than what you would need to buy property directly. For investors seeking to diversify their portfolio to include real estate, real estate stocks provide an option to do this at almost any price point.
Some brokerages even allow you to trade stocks without commissions, which is certainly not the case when buying and selling actual real estate.
If you’ve ever received investment advice, diversification is a guiding principle.
Don’t put all your eggs in one basket, right?
Real estate stocks enable you to allocate even modest amounts of investment funds among several real estate stocks. To achieve anything close to the same level of diversity when investing in real estate property, you’d need exponentially more money to do so.
Types of Real Estate Stocks To Consider
Real estate stocks are a broad category because they include any publicly traded company that touches the real estate market in some way, shape, or form. This can include:
- Technology companies, like Zillow (NASDAQ:ZG)
- Manufacturers, like U.S. Concrete (NASDAQ:USCR)
- Developers and builders, like Toll Brothers (NYSE:TOL)
- Real estate brokers and agencies, like ReMax (NYSE:RMAX)
- Home improvement retailers, like Home Depot (NYSE:HD)
- Property management and leasing companies, like Cushman & Wakefield (NYSE:CWK)
- Mortgage companies, like Quicken Loans (NYSE:RKT)
- REITs, like Simon Property Group (NYSE:SPG)
By investing in real estate stocks you gain exposure to both the real estate market as well as the business models built around that market.
And, if you don’t want to choose individual stocks, you can consider a real estate exchange-traded fund (ETF).
Real estate exchange-traded funds (ETFs) allow you to invest in a number of real estate stocks at once. By doing so, you have the potential to capture gains of high-performing real estate stocks, and at the same time, you mitigate your exposure to real estate stocks that aren’t doing as well.
What Are REITs, and How Are They Different?
While real estate stocks are simply stocks from a variety of industries that touch the real estate market, REITs are a unique class of real estate stock that actually own and operate real estate.
Another difference is that REITs receive special tax treatment and pay no corporate income tax because of the way they are structured. To qualify for such treatment, REITs are required to pay out 90% of their earnings as dividends. These larger dividends provide investors with income and protect them from the ups and downs in the stock market
Similar to mutual funds, REITs pool money from many investors and then invest in anything from office buildings and shopping malls to hotels, resorts, and apartment complexes. Each REIT unit you purchase represents a proportional ownership share in the REIT’s underlying properties.
And while investors often invest in real estate stocks looking primarily for growth, REITs are attractive to investors seeking income with higher yields when compared to other traditional fixed income investments. The most reliable REITs have a track record of paying significant dividends with the potential for even more growth.
REITs provide an interesting way for investors to invest in real estate without having to actually buy or manage the property, which can often cause many headaches. Investing in a REIT also enables investors to spread their investment risk among several properties rather than investing in a single property.
There are three types of REITs:
- Equity REITs: These operate the way a landlord would. Equity REITs own the underlying real estate, handle upkeep of the property, and collect rent checks from occupants.
- Mortgage REITs (mREITs): mREITs don’t own the underlying real estate property. Instead, they own debt securities backed by the property. So if you took out a mortgage on a commercial property, the mREIT can buy that mortgage from the original lender and collect the monthly payments from you. Because mREITs are significantly impacted by interest rate volatility, they generally come with more risk, and as a result, the dividend payout is typically higher as well.
- Hybrid REITs: As the name implies, these are a combination of equity REITs and mREITS. In the portfolios of hybrid REITs, you’ll see that they own both real estate properties and commercial property mortgages.
How To Buy Real Estate Stocks
Buying stocks from any asset class is a pretty simple process when you know what you’re looking for.
Save money, choose a brokerage account, identify a real estate stock that fits predetermined criteria, and violá — you own real estate stock.
But the key to buying the right real estate stock, however, is that predetermined criteria. Having the right perspective and asking the right questions will help you approach investing in a strategic and balanced way.
The Right Perspective
When seeking perspective about investing, it’s never a bad idea to follow advice from Warren Buffett. And according to Buffett, “You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.”
How you think about real estate stocks can be important. Rather than looking at an investment in real estate stocks as an intangible piece of your portfolio, think about your real estate stocks like you would an investment in real estate property that you would hold for the long term.
If you had invested that money into property, you would want to avoid buying and selling with every market fluctuation. The same mindset can benefit you when investing in real estate stocks.
Indicators To Look For
Any investment comes with risk. But if you incorporate a strategic and balanced approach, you will be more likely to make informed decisions and mitigate your risk as much as possible.
- Learn about the management team: It will be important to choose stocks who place importance on hiring good stewards.
- Understand the cyclical nature of real estate: Real estate stocks can be cyclical just like the real estate market itself. So whether you are investing in industrial, commercial, or residential real estate stocks, timing can become critical. As a result, it’s important to understand when the market typically experiences revenue growth and when results are likely to flatten out or decline.
- Consider current events from a unique perspective: When making decisions about real estate stocks, just like with any other investment, be sure to look around at what’s happening in the world. For example, during the COVID-19 pandemic, record numbers of people in the United States and around the world lost their jobs. Unable to make mortgage or rental payments, many people also found themselves downsizing or facing eviction. Such an environment could indicate that public storage and self-storage REITs might be an area worth researching.
Which Real Estate Stocks Are Right for You?
Asking good questions is an essential building block when it comes to creating a solid investment portfolio. It’s critical to understand how the company makes money, any risks or opportunities on the horizon, and whether the pricing is reasonable.
Because after all, you want your investment to make money for you. Cash is what you’ll need to retire and stay retired. It will help you weather financially turbulent times.