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3 Reasons to Buy REITs Instead of Real Estate

Christopher Liew, CFA
·4 min read
Real Estate Investment Trust REIT on double exsposure business background.

Some people become real estate millionaires, even if they don’t own real estate. Not everyone is cut out to be landlords or manage individual properties. However, they can still receive rental-like income. Real estate investment trusts (REITs) are alternative investments to create wealth in the real estate sector.

Warren Buffett, for instance, rarely invests in real estate. The value investor bought his modest home in Omaha, Nebraska, in 1958 but has never relocated since. While his property is only .001% of his overall wealth, he said it was his third-best investment ever.

As of December 31, 2020, Buffett, through Berkshire Hathaway, has only one REIT investment. Store Capital is the odd man out, considering that the real estate sector isn’t popular with the GOAT of investing. Still, people will listen to Buffett’s reasons why REITs are better investment choices than owning actual real estate.

Know your limitations

Buffett admits that his conglomerate can’t compete with gurus or experts in the real estate space. Most real estate investors often overestimate their abilities to manage rental properties. Watching a YouTube video won’t make you a successful landlord. The reality is different. Warren Buffett advises people to be very realistic about their limitations. You can only achieve good results in rental properties if you’re 100% focused on real estate.

Overvalued market

In Canada, housing markets are red hot, although it’s not reflected in REITs’ performance. The retail or commercial sectors are challenged and continue to struggle. Also, the bubble could burst anytime soon and send prices plunging. While mispricing in real estate is rare, says Buffett, you’re likely to find better deals in the stock market, including REITs. The underlying properties are more valuable than ever.

Management intensive

Besides a smaller cash outlay than acquiring actual properties, REITs come without headaches. Rental properties are management intensive as you must deal with tenants, vacancy risks, and maintenance costs. Thus, property management expenses could eat up a chunk of your profitability. With REITs, you’re a mock landlord collecting rent minus the inherent responsibilities.

Strong comeback

RioCan (TSX:REI.UN), a top Canadian REIT, suffered the worst during the COVID-19 year. Investors didn’t expect the health crisis to force management’s hands to slash dividends by 33%. The move was necessary to preserve or maintain the strongest balance sheet as much as possible.

Besides the haircut on dividends, investors lost 31.8% on the stock in 2020. Thus far, in 2021, the share price is $21.02 — a year-to-date gain of 27.6%. If you were to invest today, the $6.68 billion REIT pays a respectable 4.59% dividend.

For 2020, RioCan reported a net loss of $64.8 billion versus the $775.8 net income in 2019. Because of the pandemic’s unparalleled impact on the business, rent collections suffered while the active transaction market was fewer. Tenant restructuring was the predominant activity.

Nevertheless, RioCan is confident it could bounce back from the carnage. The robust pipeline and development program should deliver new and diversified sources of income and cash flow. The move to shift away from retail to mixed-use properties is a clever strategy. Investors should be happy.

Discounted opportunities

Value investors like Buffett prey on high-quality assets at a discount to fair value. RioCan and similar REITs are discounted opportunities. You don’t need to scale or manage yet receive passive income as a real landlord would.

The post 3 Reasons to Buy REITs Instead of Real Estate appeared first on The Motley Fool Canada.

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Fool contributor Christopher Liew has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: short January 2023 $200 puts on Berkshire Hathaway (B shares), short June 2021 $240 calls on Berkshire Hathaway (B shares), and long January 2023 $200 calls on Berkshire Hathaway (B shares).

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