The Perfect Passive Income Real Estate Investment

A​n investment in REITs offers the benefits of Real Estate Investing without the hassle of buying individual properties. Find out why it should be part of everyone’s investment strategy.

Ever since Will Rogers made his famous quote about Real Estate Investing in the 1930s, people have been lining up for their share of the profits. Few investments have created as many family legacies and created more wealth than Real Estate.

My own experience in real estate investing started in 2002, just after getting out of the Marine Corps. I took a job as a commercial property agent and started rehabbing single-family houses for rent in my spare time. Of all the passive income strategies in which I’ve invested, real estate has been my favorite,

…and also one of the most frustrating.

Promises of a six-figure income as renters pay off your mortgages and investing strategies that involve little more than collecting your checks are about as far from reality as a bad sci-fi flick. I had as many as six properties before selling all but a couple in 2006. Phone calls come in at all hours of the night for repairs and bookkeeping alone can be a part-time job.

I still own a few rental properties but have found a better investment in real estate. One that offers the upside of real estate but without the tenant hassles and large down-payment of buying property.

Besides a great opportunity for real estate-related profits, the investment has beaten the return on stocks over the last four decades. It’s one of the few investments that everyone should put in their portfolio.

Real Estate Investing without the Headaches and Hassles

Real estate investment trusts (REITs) are a special type of corporation established by law in 1960. These companies own real estate properties and do not have to pay corporate income taxes as long as they pay out at least 90% of income to investors.

As you can imagine, not having to pay corporate taxes is a huge advantage and REITs hold more than $2 trillion of commercial real estate in the United States and globally. Companies like McDonald’s and Sears have considered selling their real estate into a REIT and then just renting it back to benefit from the tax advantages.

For investors, this means a strong source of income from your investment. According to the National Association of REITs (NAREIT), the average dividend yield of 4.1% is nearly twice as much paid by stocks in the S&P 500 with an average 2.1% dividend yield.

Most REITs invest in commercial real estate along a specific segment like office, industrial, health care or multi-family residential. The company manages the properties and sells shares to investors just like any company in the stock market.

The great thing about investing in REITs rather than directly buying properties yourself is that you get instant diversification across hundreds of properties and professional management. You don’t have to worry about a drop in the local economy and the rental market, a big problem for most individual real estate investors.

Beyond the cash flow you get from REITs, they also provide a solid return on the price of the shares. REITs averaged an annual return of 13.5% over more than four decades to 2013, well above the 10.2% annualized return on stocks in the S&P 500.

How to Invest in REITs

There are hundreds of different REITs in which you can invest. As with any sound investing strategy, you should diversify your investment across multiple companies so you aren’t overly exposed to problems at any specific one. You’ll want to look into buying REITs that own different types of commercial properties as well as those that hold properties across the country.

One popular strategy for many investors is to buy shares in a REIT fund, an investment that itself holds shares in individual REITs. Buying shares of a fund like the Vanguard REIT ETF (NYSE: VNQ) gives you a share of the 145 different REITs in which the fund invests, immediately spreading your investment out across different property types and different locations.

REITs may not offer the upside potential of owning your own real estate properties and I still like the pride of ownership I get from developing real estate. As for a source of passive income, it’s tough to find a better investment than REITs. Like any one investment, you shouldn’t put all your monetary eggs in one basket but putting some money to work in REITs is something everyone should consider.

Author bio: Joseph Hogue, CFA is an investment analyst and author of The Passive Income Myth: How to Create a Stream of Income from Real Estate, Blogging, Stocks and Bonds. Join the community on PeerFinance101 for more tips on investing, managing debt and reaching your financial goals.