None of them talk about keeping the property as a
rental and there’s a good reason for that, it’s just
another job and usually a royal pain in the butt. I speak
from my own personal experience of years of owning
rental properties. There are better ways to make a lot
of money in Real Estate and one of them is talked
about below. Check it out…
Rental investments are very popular among
conservative income investors, and rightfully so.
Renting living space to other individuals is one of the
oldest professions in the world, and it remains an
exceptionally lucrative business to be in today. We note
5 main reasons why investors should invest in “rentals”
as part of an overall portfolio strategy:
- Consistent and high income: Since having a roof over one’s head is a vital necessity, the cyclicality of the demand for properties is greatly reduced, regardless of economic conditions. In a recession, tenants may receive a rent cut to keep occupancies at high levels, but overall, the income tends to remain relatively resilient and consistent over the full cycle.
- Long-term appreciation: Well-located rentals are a limited commodity with ever-growing demand. The result is price appreciation – often well in excess of inflation with growing rents and values. Moreover, there is a clear trend towards ever lower ownership rate and, therefore, rentals continue to benefit from an ever-larger demand pool.
- Inflation protection: Real estate and especially rentals can serve as valuable hedges against the risk of accelerating inflation. Leases are generally no longer than one year long – allowing for regular rent increases when warranted.
- Leveraged returns: Leverage may boost returns but also amplifies risks. That said, since rentals tend to produce consistent and predictable income, investors are commonly able to get away with moderate leverage over the full cycle without sinking the ship. It may result in greater asymmetrical risk-to-reward outcomes over time.
Now, while we like rentals from a financial perspective, we hate to manage them because of the 3 Ts:
What good is it to generate an 8% cash flow yield if it becomes a part-time job with finding tenants, evicting existing ones, repairing toilets, finding contractors, monitoring payments, etc…
The truth is that owning rentals often gets closer to operating a real business, rather than just collecting passive income from an investment. And, this is why rental investments often become real nightmare investments to so many. People buy them expecting consistent cash flow and the peace of mind of being insulated from the stock market volatility. What they get is a part-time job with constant worrying in so many cases.
Before You Buy a Rental…
So, before you buy a rental, make sure that you understand your task at hand.
- Finding good quality tenants: advertising online, making house showings, running credit checks, assessing the tenant’s integrity through interviews.
- Legal work: signing the lease, getting a deposit, setting up a limited liability company, finding a good lawyer for when the need comes.
- Maintenance: roofs will leak, toilets will get clogged, carpet will get stained, etc.
- Contractors: interview them, check any referrals, manage and control the work and cost.
- Customer service: tenants will call you at all time of the day and night. Some will be easier to handle, and some will be extremely picky and difficult. You will know what you got only once the lease is signed and the person moves in.
- Financial stress: a rental investment is likely to represent a significant portion of our net worth, and it will cause financial stress whenever repairs come up, property taxes are raised, tenants do not pay their rent on time or at all, you get sued by tenants or contractors, banks require payments.
You get the point. This is NOT a passive investment. Managing all this next to a full-time job can quickly become a burden that is simply not worth taking – regardless of how high the return may be. You can delegate some or all of it to a property manager, but you will still need to work, but now also pay a manager.
And, it does not end here. Having been a private real estate investor, I can tell you that it is hard to find a rental that pays you enough for all the troubles that you ran into. If you do it long enough, sooner or later:
- You will get sued.
- You will have social issues with your tenants.
- You will get threatened by angry tenants, contractors, brokers, other.
- You will get tenants that completely trash your rental.
- Some tenants won’t pay their rent and refuse to move out.
- Calls in the middle of the night are not a myth.
- Surprises, surprises, and more surprises.
If you are fully aware of all this, and you still believe that the investing in rentals is the right way for you, then it is all good. For other investors who desire similar exposure with much less worries and risks, consider taking an alternative route to real estate investing.
A Much Better Alternative (for most investors)
Rentals may make sense for a few investors who are handy, enjoy the social aspect, and have ample time to deal with the work. For other people who are working a job and are not interested in taking additional work and worries, I believe that REITs provide a very attractive alternative.
REITs or “Real Estate Investment Trusts” are publicly-traded companies that invest in real estate and as such, by buying shares of the REITs, investors can participate in the return of large real estate portfolios.
Therefore, by investing in REITs, you enjoy the many benefits of rental investments along with:
- Professional management: all the unpleasant work is managed by professionals in a highly cost-efficient way thanks to economies of scale. These are people who do this full time, have great resources, and are likely to do a better job than you.
- Liquidity and low transaction cost: unlike rentals that are highly illiquid and involve up to 10% in transaction costs on day 1, REITs are publicly listed, and shares can be traded in one click of mouse at minimal cost.
- Diversification: when you invest in a REIT, you own an interest in a portfolio of 10s or 100s of properties. As such, your risk is well mitigated as compared to owning one or two rentals.
- Passive Income: REITs must, by law, pay out 90% of their net income in dividends to shareholders. In this sense, without putting in any work, you will be earning a very consistent income from a passive investment.
- Better long-term returns: research shows that REITs outperform private real estate by up to ~4% per year in the long run, thanks to scale advantages, cost efficiencies, better management practices, and higher cash flow growth:
In other words, if you had a million dollars 25 years ago and invested it in REITs rather than in rentals, you would potentially have nearly two and half times more despite putting it less efforts and taking less risks.
Our Approach to REIT Investing
Managing rentals is a huge hassle. That said, analyzing REITs is no walk in the park either. It requires specialist skills that are not widely available, and there is a strong need for professional research to sort out the worthwhile from the wobbly.
One easy option for REIT investing is to simply invest in the broader REIT market, utilizing an index fund such as the Vanguard REIT fund (VNQ). However, this means buying every REIT in the index, regardless of its current price, quality, prospects, or management. While “know-nothing investors” (to borrow a term from Charlie Munger) may find this broad diversification useful, we believe (as does Charlie Munger) that using an intelligent analysis of the qualitative and quantitative aspects of each REIT in order to pick and choose the most opportunistic investments will provide the best total returns over the long term.
At High Yield Landlord, we spend hundreds of hours and thousands of dollars researching the REIT market in order to target the highest quality REITs that are being offered for sale by Mr. Market at low valuations. As a result, we are able to achieve superior dividend yields (currently 7.86% weighted average in our real-money portfolio) at sustainable dividend payout ratios (currently 70.4% weighted average in our real-money portfolio), thereby giving us strong current income (enabling us to capitalize on short-term volatility by averaging down on top opportunities) and superior total returns over time.
This is not, however, possible for everyone. We do this full time, it is our only focus, we have great resources, and access to management teams to conduct interviews. (Disclosure: the objective of High Yield Landlord is to streamline this research process to the public and allow interested members to emulate our strategy.)
Some of our recent successful investments include the 12% yielding infrastructure REIT Uniti (UNIT), the office investor Brookfield Property (BPY) and the more defensive, yet undervalued net lease REIT W.P Carey (WPC).
Bottom Line – Don’t Let Tenants, Toilets, and Trash Ruin Your Life
Rental investments come with many benefits including high and consistent income, long-term appreciation and inflation protection. On the other hand, they also come with significant managerial burdens – making them unsuitable for most investors. REITs offer similar exposure and income but with the added benefits of professional management, liquidity, low transaction cost, diversification, true passive income and long-term outperformance. The best active REIT investors have managed to reach up to +22% annual returns over the past decades:
This is what we aim to do at “High Yield Landlord” by specializing in REIT investing. We want to maximize our chances of generating high total returns with limited risk while remaining liquid and in control of our real estate investment. We believe that the best way to achieve this is by investing in REITs, not in private rental properties.
A Note about REIT Investing: To succeed as a REIT investor and earn high consistent income, we recommend to:
Closely monitor your REITs, including quarterly NOI and FFO performance.
Diversify your REIT portfolio with at least ten companies (there are over 200 publicly traded REITs, so please be selective).
Identify REITs with strong long-term fundamentals but affected by temporary challenges causing their valuation to decline and yields to rise.
Be ready to take advantage of market volatility and look for opportunistic buying points.
Filed under: Real Estate