Non-Traditional Income Investment Ideas
Non-traditional income investments – part 1 of 3
There really wasn’t much of significance that happened in the markets this past week. Matter of fact, each of the three major market indicators ended only fractionally changed from the week before. (1)
With the S&P500 trading very close to its all-time high, and with no real news to distract them, traders will be watching to see if the index trades through that high point – or not. Activity around that level could lead to additional market fluctuations in either direction in the near-term.
The quest
For the past five years, at least, there has been a drumbeat of demand for income from all levels of investors. (Income for these purposes meaning only current cash flow.) Even today, with interest rates likely to remain at low levels for a while yet, the search continues.
I referred to one sector last week – the utilities – that has benefited from the demand. Senior floating-rate bond funds and high-yield bonds are two other areas that have seen increased inflows of cash as well. These are all fairly well-known options.
However, based on conversations I have with different folks, I’ve found a low awareness of the workings of the three types I’m going to be talking about in this and the next couple issues. They are real estate investment trusts, master limited partnerships and royalty trusts.
Major, big, huge disclaimer
While issues in each of these categories trade like stocks – they aren’t. I’ll explain how in each segment. Most important, be sure to check into each issue you consider from any of the sectors to ensure you’re comfortable with how, where or if it can fit into your investing strategy.
Real estate investment trust
First created in 1960, this type investment – known best by its acronym; REIT (pronounced “reet”) – is a way for an investor to participate in the ownership of many kinds of real estate properties, in many different markets and in many different categories…without the challenges of actual management. A REIT owns and manages the income-producing properties for its shareholders. So, you do have the option for wide diversification. Nonetheless, the share prices of all REITs will tend to follow the real estate market and its fortunes.
What each one has to do
REITs are pretty highly regulated, in order to qualify for trust status. As a result, each one MUST be set up as follows:
– At least 75% of the REIT assets must be in real estate, cash and government securities
– At least 75% of the gross income must flow from rents, interest on mortgages or other real estate investments
Types of properties
As a group, REITs are primarily invested in major, Class A property types. There are a number of sectors into which you can invest. About two-thirds of total investment falls into office buildings, apartment complexes, shopping centers, regional malls and various industrial buildings. The remainder goes into financial REITs, as well as those for health-care, hotels and specialty segments including timber or movie theaters.
General investment considerations
Income being the basis of this letter, while the individual sectors can vary, the average yield across the sectors is currently 4.40% (2). The incomes have proven to be fairly steady over time as the cash flows are based on long-term leases.|
Within each REIT, you own multiple properties. It’s like having a mutual fund of real estate properties. This helps diversify your risk among properties and locations.
Like most common stock, these pay their dividends quarterly and will send a 1009-DIV to you. That will be helpful as these dividends have three components. A portion of the total will be ordinary income, some capital gains and a portion being return of capital. While taxes will be due on your dividends, this last part isn’t taxed as ordinary income. It actually goes to reduce your cost basis in the shares. The good news is that, when you liquidate your shares, the difference between the adjusted share price and the sale price is taxed at capital gains rates.
Speaking of liquidity, the publicly-traded REITs can be bought and sold on an exchange, so the price and financial information is also readily available.
REITs have proven to be a good, non-correlated asset to have in a portfolio. (Non-correlated means the asset tends to trade in the opposite direction of stocks, in general.) Inasmuch as they’re real estate based, they also would be a positive asset in a rising inflation economy – unlike bonds. Further, as leases are renewed and rents increased, shareholders participate in that as well.
If you have questions about how this class of asset could fit into your portfolio, please call or email me.
Cheers!
Mike
509-747-3323
(1) CNBC, 21 Feb 2014
(2) REIT Growth and Income Monitor, 14 Jan 2014
Securities and Investment Advisory Services offered through KMS Financial Services, Inc.
To get an overview of economic conditions, use this link. It’s updated monthly.http://www.russell.com/Helping-Advisors/Markets/EconomicIndicatorsDashboard.aspx
Past performance is not indicative of future returns.Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment. Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
