Cleaning up my REIT allocation

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
InvestInLife
Posts: 153
Joined: Mon Aug 22, 2016 2:36 pm

Cleaning up my REIT allocation

Post by InvestInLife »

I collected REITs in my dividend-chasing months before becoming a boglehead. I now understand owning individual stocks carries higher risk. I think of holding REITs for income payout as an alternative to direct real estate. The income payout with my individual stocks is high (6-10%) compared to REIT index funds (2%). My investment perspective has changed to focus on growth, but I have kept these REITs in my 401k as I watch their values spike up and down while raking in consistent dividends.

My question is what do REIT index funds do with their dividends since they don't pay them to shareholders? Do they reinvest them into the fund and then give shareholders the reduced dividend around 2%?

I have four individual REITs left: ARI, HCP, O, OHI. Four isn't highly diverse, but they are considered high quality, there is variation in market focus (healthcare, commercial, retail, mortgage) and the dividend return is high relative to when I purchased them. So far they tend to balance each other out; ie. ARI is up 24%, HCP is down 12%, O is down 6%, OHI is up 2%.

My next question is whether Ill need to convert to a REIT sector fund? I am less confident about thinking of REITs for growth. I sleep ok at night with my current holdings. But maybe I am missing something.
When I rebalance, I have been keeping these at equal ratios...so if I rebalanced today I would sell ARI and buy HCP. Is this the right way to do it?

Thanks.
User avatar
grabiner
Advisory Board
Posts: 28742
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Cleaning up my REIT allocation

Post by grabiner »

InvestInLife wrote:My question is what do REIT index funds do with their dividends since they don't pay them to shareholders? Do they reinvest them into the fund and then give shareholders the reduced dividend around 2%?
REIT index funds, like all stock funds, pay shareholders all distributions they receive, less expenses. Vanguard REIT Index reports a 3.97% SEC unadjusted yield; that implies that its REITs distributed 4.09% to shareholders (annualized), and the fund took out 0.12% for expenses.

The reason this is reported as an unadjusted yield is that some of the distributions were not dividends; REITs often pay out return of capital, which accounts for depreciation on the properties. This is only relevant in a taxable account, where a return-of-capital distribution is not taxed but reduces your basis. The estimated adjusted yield is 2.51%.
I have four individual REITs left: ARI, HCP, O, OHI. Four isn't highly diverse, but they are considered high quality, there is variation in market focus (healthcare, commercial, retail, mortgage) and the dividend return is high relative to when I purchased them. So far they tend to balance each other out; ie. ARI is up 24%, HCP is down 12%, O is down 6%, OHI is up 2%.

My next question is whether Ill need to convert to a REIT sector fund? I am less confident about thinking of REITs for growth. I sleep ok at night with my current holdings. But maybe I am missing something.
How large a part of your portfolio are these? The advantage of the index fund is better diversification and easier management (you don't have to buy and sell to stay in balance), but if the individual REITs are 1% each of your portfolio, the diversification doesn't matter that much.
Wiki David Grabiner
User avatar
munemaker
Posts: 4174
Joined: Sat Jan 18, 2014 6:14 pm

Re: Cleaning up my REIT allocation

Post by munemaker »

grabiner wrote:
REIT index funds, like all stock funds, pay shareholders all distributions they receive, less expenses.
Individual REITs, unlike individual stocks, are required to pay out 90% of their taxable income as dividends.
4nwestsaylng
Posts: 514
Joined: Thu Jun 15, 2017 2:03 am

Re: Cleaning up my REIT allocation

Post by 4nwestsaylng »

InvestInLife wrote:My question is what do REIT index funds do with their dividends since they don't pay them to shareholders? Do they reinvest them into the fund and then give shareholders the reduced dividend around 2%?
grabiner wrote:REIT index funds, like all stock funds, pay shareholders all distributions they receive, less expenses. Vanguard REIT Index reports a 3.97% SEC unadjusted yield; that implies that its REITs distributed 4.09% to shareholders (annualized), and the fund took out 0.12% for expenses.

The reason this is reported as an unadjusted yield is that some of the distributions were not dividends; REITs often pay out return of capital, which accounts for depreciation on the properties. This is only relevant in a taxable account, where a return-of-capital distribution is not taxed but reduces your basis. The estimated adjusted yield is 2.51%.

I don't really understand the "return of capital" concept, I understand it is a pass-thru of depreciation. If the price of the REIT does not drop, and you get a portion as return of capital, it reduces your cost basis when you sell the shares, if you do. So when you sell you owe LT or ST capital gains on that return of capital portion, if the shares are indeed higher than your cost basis at the time of sale? Is return of capital essentially an indirect form of capital gain? What if the shares fall to below your calculated cost basis (price paid plus adjusted down for all the return of capital you have received), you can write off the difference as a capital loss if you sell the shares? e.g. you pay $50 for a share, hold for three years, over those three years you get a total of $1.50 in return of capital, and at end of three years the price suddenly drops from $50 a share to $45 a share. Your cost basis is $48.50, is your long term capital loss $3.50 instead of $5 if you sell at $45? Also is the dividend portion of the return a qualified dividend or is is taxed at marginal tax rates?

This is only relevant in a taxable account. Is there any downside to having the REIT in a tax deferred account? You get the unadjsted return, which includes return of capital, but cost basis is not an issue.ie can you regard the unadjusted return as the "real" return even though it contains some return of capital, as long as the share price is stable? Is the portion that is "return of capital" essentially a form of capital gain you are earning in the deferred account (it is reducing your cost basis), but, like losses, is not accounted for, since any earnings are ultimately taxed as income when withdrawn.

Thanks for input on this.
User avatar
Pajamas
Posts: 6015
Joined: Sun Jun 03, 2012 6:32 pm

Re: Cleaning up my REIT allocation

Post by Pajamas »

I don't really understand the "return of capital" concept, I understand it is a pass-thru of depreciation. If the price of the REIT does not drop, and you get a portion as return of capital, it reduces your cost basis when you sell the shares, if you do. So when you sell you owe LT or ST capital gains on that return of capital portion, if the shares are indeed higher than your cost basis at the time of sale? Yes. Is return of capital essentially an indirect form of capital gain? Yes.What if the shares fall to below your calculated cost basis (price paid plus adjusted down for all the return of capital you have received), you can write off the difference as a capital loss if you sell the shares? e.g. you pay $50 for a share, hold for three years, over those three years you get a total of $1.50 in return of capital, and at end of three years the price suddenly drops from $50 a share to $45 a share. Your cost basis is $48.50, is your long term capital loss $3.50 instead of $5 if you sell at $45? Yes. Also is the dividend portion of the return a qualified dividend or is is taxed at marginal tax rates? REIT dividends are generally not qualified, including on preferred shares, because the REIT structure is already tax-advantaged as it passes income through to shareholders without taxing it at the corporate level as long as the REIT distributes 90% of taxable income. Some of the dividend could be qualified if money were received by the REIT in the form of qualified dividends, but that is somewhat rare. You can always look at the REIT's website to see how the past dividends were allocated, understanding that it can change.

This is only relevant in a taxable account. Is there any downside to having the REIT in a tax deferred account? You get the unadjsted return, which includes return of capital, but cost basis is not an issue.ie can you regard the unadjusted return as the "real" return even though it contains some return of capital, as long as the share price is stable? Is the portion that is "return of capital" essentially a form of capital gain you are earning in the deferred account (it is reducing your cost basis), but, like losses, is not accounted for, since any earnings are ultimately taxed as income when withdrawn. REITs are best held in tax-deferred accounts if you have enough income to pay taxes in the first place. An IRA acts as a black box for tax purposes as your withdrawals are taxed as ordinary income regardless of whether they were capital gains or dividends so you don't really care about any of these issues in a tax-deferred account.

Thanks for input on this.[/quote]

One advantage of a REIT that pays some or all of the dividend as return of capital is that it delays any taxes on the dividend in a taxable account and also those taxes may be at the lower capital gains rate rather than the rate for ordinary income. That creates a further advantage if there is a good reason to limit the amount of income you report for tax purposes, such as for qualifying for some benefits.
4nwestsaylng
Posts: 514
Joined: Thu Jun 15, 2017 2:03 am

Re: Cleaning up my REIT allocation

Post by 4nwestsaylng »

Thanks,pajamas, you cleared it up. From further reading(REIT.com, professor Larry Stern) each REIT has a different mix of how much the dividend is composed of ordinary income passed through, vs return of capital, vs even long term capital gains (primarily in timber REITs), and sometimes even some qualified dividends if the REIT gets any income from a company that pays corporate income tax.

Is there any data on the components of the VNQ dividend, ie what percent ordinary income vs return of capital. I see your point that if a good REIT was primarily return of capital in its dividend, then in that case it could have a place in a taxable account, vs if dividend is primarily ordinary income, would be better in tax deferred.
4nwestsaylng
Posts: 514
Joined: Thu Jun 15, 2017 2:03 am

Re: Cleaning up my REIT allocation

Post by 4nwestsaylng »

.....
Last edited by 4nwestsaylng on Wed Jul 05, 2017 11:28 pm, edited 1 time in total.
4nwestsaylng
Posts: 514
Joined: Thu Jun 15, 2017 2:03 am

Re: Cleaning up my REIT allocation

Post by 4nwestsaylng »

grabiner wrote:
InvestInLife wrote:My question is what do REIT index funds do with their dividends since they don't pay them to shareholders? Do they reinvest them into the fund and then give shareholders the reduced dividend around 2%?
REIT index funds, like all stock funds, pay shareholders all distributions they receive, less expenses. Vanguard REIT Index reports a 3.97% SEC unadjusted yield; that implies that its REITs distributed 4.09% to shareholders (annualized), and the fund took out 0.12% for expenses.

The reason this is reported as an unadjusted yield is that some of the distributions were not dividends; REITs often pay out return of capital, which accounts for depreciation on the properties. This is only relevant in a taxable account, where a return-of-capital distribution is not taxed but reduces your basis. The estimated adjusted yield is 2.51%.

Grabiner answered my question, VNQ dividend is 2.51% income (adjusted yield), the balance (3.97-2.51) is return of capital.[/quote]
Topic Author
InvestInLife
Posts: 153
Joined: Mon Aug 22, 2016 2:36 pm

Re: Cleaning up my REIT allocation

Post by InvestInLife »

Revisiting this topic, since I looked at how my REITs have performed since purchase, and cumulatively they are down almost 8%. Largely from HCP doing so poorly this year, although everyone says HCP is cleaning up its act and is expected to bounce upward long term. My four individual REITs were purchased at prices that together yield appx 7.4% annually, which seems to be a decent yield. I have these in my 401k to think of as income. I am midway in the accumulation stage at 36 and hope to retire mid-forties. These stocks represent 6% of my portfolio. But REIT mutual fund FSRVX is up 3.72% in the last year, and 10.34% life.

So, back to my original question: is it ok to hold REITs individually? Do some of you do it? Individual REITs were initially presented to me like "real estate mutual funds" that each hold a diverse array of rental properties.
Would you say it is better form to ignore today's value drop and continue to hold and reinvest high-yielding dividends, or sell all four, eat the loss, and open an REIT index fund?
livesoft
Posts: 74525
Joined: Thu Mar 01, 2007 8:00 pm

Re: Cleaning up my REIT allocation

Post by livesoft »

I am on record that I would not buy any individual stocks and I would not buy a REIT index fund until it had a bona fide Really Bad Day. So that means sell your REITs and invest in something else for awhile.
Wiki This signature message sponsored by sscritic: Learn to fish.
Post Reply