Understanding REITs and Their Place in Your Portfolio

Posted on Fri, Mar 06, 2020 ©2021 Drucker & Scaccetti


By: Stuart Shikiar, Albert Sipzener, Lockwood Sloan and Sam Shikiar


Real estate has been a time-tested addition to investor portfolios. Real Estate Investment Trusts, or REITs, provide an opportunity for tax-advantaged income investing. Today’s post features a discussion by the team at Shikiar Asset Management, a New York-based registered investment advisor and long-time friend of Drucker & Scaccetti.  Here is what they have to say about REITs…


Real Estate Investment Trusts (REITs) have been a central component of our strategy for several years. REITs offer investors the benefits of exposure to real estate coupled with the ease and advantages of investing in publicly traded equities, including daily liquidity. They have historically provided dividend-based income, competitive market performance, transparency, inflation protection and portfolio diversification. Additionally, REITs are required by law to distribute each year at least 90 percent of their taxable income as dividends to their shareholders.


Consequently, REITs tend to historically be among those companies paying the highest dividend yields that can emanate from relatively stable and predictable streams of contractual rents paid by the tenants who occupy their properties. In today’s low interest rate environment (U.S. 10-Year Government Debt is yielding close to 1.00%) we believe REIT dividend yields are attractive and REIT companies can profitably finance new purchases with inexpensive debt.


We also believe REITs are highly tax-efficient investments. The part of REIT distributions that is considered ordinary income qualifies for the pass-through tax deduction from the Tax Cuts and Jobs Act. Also known as the Qualified Business Income (QBI) deduction, this allows up to 20% of taxpayers' income from pass-through entities to be deducted, resulting in lower effective income tax rates.


According to the National Association of Real Estate Investment Trusts, the U.S. REIT industry has grown over the last several years to a total addressable market of approximately $1 trillion in equity market capitalization, representing nearly $3 trillion in gross real estate assets, with more than $2 trillion of that total from publicly listed and non-listed REITs, with the remainder being privately held. The significant growth in REITs engendered the creation of the new Real Estate headline sector in the Global Industry Classification Standard (GICS) in 2016. In our view, giving REITs their own GICS sector in the S&P 500 Index validated the continual development and growth of this asset class, while helping them to become considerably more visible and better understood by the investment community.


Given the importance of yield and income generation to our clients, several years ago we elected to selectively incorporate numerous REITs with attractive valuations and solid fundamentals across diverse industries into portfolios.  We believe in the importance of conducting detailed proprietary equity research on all portfolio holdings, and REITs are no exception. While well-diversified across a range of industries, our REIT holdings share the following important underlying characteristics:


  1. Trade at attractive prices relative to their net asset value.
  2. Have well-capitalized balance sheets.
  3. Are run by highly experienced senior management teams.
  4. Possess the capability and skill to execute accretive acquisitions.
  5. Operate in industries with a high degree of visibility and sustainable secular growth (with a particular focus on industrial REITs).
  6. Have steady track records of high occupancy levels (with many of our holdings near 100%) and balanced lease expiration portfolios.
  7. Generate corporate earnings or Funds from Operations (FFO) that meet or exceeds quarterly cash dividend payments.
  8. Implement regular cash dividend increases as an integral part of their underlying business models. 

When studying REITs, we see a wide range of quality on the above metrics, which is why we prefer an actively managed approach in this sector.


Our friends at Shikiar Asset Management can be reached at www.shikiar.com. Talk to them for more information about REITS and how they can complement your investment portfolio. To learn more about how the QBI deduction impacts your REIT investment or other income, contact The Tax Warriors® at Drucker & Scaccetti. We are always prepared to help.


As with any article that discusses tax treatment, the usual disclaimers apply: This is a generalized overview, does not represent advice, and may not apply to your situation. Do not use this article to make tax or investment decisions. Consult your tax expert or call us to be that expert.

Topics: Real Estate Ownership, REIT, REITS, Qualified business income deduction, Section 199A QBI, Tax-advantage, Shikiar Asset Management, NAREIT, Investment portfolio, GICS, Funds from Operations

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