Retire Early With REIT Dividends
The 60/40 Rule has long been regarded as a prudent investment strategy, and is aimed at providing an optimal mix of growth, safety, and income. It refers to an asset allocation mix of 60% stocks, and 40% bonds, and for many years, this strategy has been viewed as the golden rule of investing.
However, I believe the current macroeconomic environment has rendered this rule obsolete. That’s because bond and index funds are offering yields near all-time lows. I believe investors who are searching for reliable dividend income are far better serve by investing in REITs, many of which are providing investors with dividend yields well in excess of the dividend yields of bonds and index funds.
Paltry Yields Are No Fun
For one thing, treasury and corporate bond yields are now sitting near their all-time lows. As seen below, the Vanguard Total Bond Market ETF is currently providing the lowest yield in over a decade, at just 2.22%.
Source: YCharts
This means that an investor with a $1 million portfolio, and a 40% allocation to this well-regarded bond ETF would only receive $8,880 in annual income from this investment. That’s hardly enough to keep up with the long-term 2% annual inflation target that the Federal Reserve has targeted for a normal-functioning economy, and is just 1 percentage point above the 1.2% inflation rate, as recorded by the Bureau of Labor Statistics for the month of November, 2020. This means that investors in this particular ETF are getting only a 1% rate of return in real dollar terms.
The picture gets even worse for the 10-Year Treasury Bond, which is often regarded as the gold standard for safe bond yields. As seen below, the current 0.94% yield is close to the all-time low (set in 2020) in over a century.
Source: Multipl
If one were to lock-in a 10-year treasury bond purchase today, they would actually be of losing money in real terms, since the 0.94% Treasury yield sits below the aforementioned 1.2% rate of inflation. Should interest rates rise to the 2% target rate set by the Federal Reserve, investors would actually be losing over 1% per year in real dollar terms over the next decade.
Investors looking to the S&P 500 won’t find much reprieve, since the current yield of the S&P 500 is also sitting near an all-time low, at 1.6%. In a bit of consolation, however, the S&P 500 dividend grows over time, with a 5-year CAGR (compound annual growth rate) of 7.9%, and an annual dividend growth streak of 11 consecutive years. But nonetheless, it will take many years for investors to derive any form of meaningful income from an investment in the S&P 500 today.
So what’s an investor to do for reliable income?
REITs Are A Better Option
I believe equity REITs (not mortgage REITs) are a better option for those who seek the meaningful income of a bond, with the growth kicker of equity. That’s because REITs own real property, which, in most cases, provide a durable income stream. My favorite sectors in the REIT space are Net Lease and Apartments.
Source: Realty Income Corporation website
Triple Net Lease REITs such as Realty Income Corporation and W.P. Carey own commercial properties that are leased to businesses, many of which are investment-grade rated. The beauty of the triple net lease model is that the tenant is responsible for paying for the maintenance, insurance, and property taxes on the properties. This results in a low cost structure and a high level of profitability for this asset class. Investors, meanwhile, get to enjoy dividend yields ranging from 4%-6%, with annual dividend growth rates typically ranging from 2%-5%.
Source: AvalonBay website
Apartment REITs are also a worthy consideration, with quality names like AvalonBay Communities and Camden Property Trust coming to mind. Most publicly-traded apartment REITs own high quality and well-located properties, and have held strong rent collection rates, even in 2020. Like net lease REITs, an investment in apartment REITs provide investors with a durable income stream without them having to worry about the hassles of private property ownership, and the 3 T’s (tenants, toilets, and trash) that come along with it.
Well-managed apartment REITs, currently have dividend yields between 3–5%, with dividend growth rates typically between 4%-6%.
Takeaway
The current low-yield environment has rendered the 60/40 rule to be obsolete, since investors cannot expect to receive any meaningful bond yields at present. As such, I would advocate giving REITs some consideration in lieu of bonds. Many REITs provide durable and growing income streams, which can help meet the financial obligations of retirees and non-retirees alike.
As a reminder, like all stocks, not all REITs are created equal, with some having stronger balance sheets and property types than others. Also REITs are equities and behave as such, so no REIT should be considered as being the same as a bond. Investors should look for REITs with a BBB- or better credit rating, and a dividend to FFO (funds from operations) payout ratio of 85% or below. This helps to ensure dividend safety for the REIT in the event of adverse economic conditions.
All in all, I believe investing in REITs can be a rewarding experience for those who seek a truly passive income with a durable stream of dividends. Plus, REITs come in all shapes, sizes, and forms, including data centers, cell towers, distribution warehouses, apartments, and free-standing retail (i.e. your neighborhood Taco Bell), and touch nearly every aspect of people’s lives. I’m personally invested in this sector, and view this as a being a viable path to financial independence.
This article is for informational purposes only, and is not meant to serve as financial advice. Readers should perform due diligence prior to making any investment decisions.
