Earning Dividends in Real Estate: REITs

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One of the ways that you can diversify your dividend portfolio, while also providing you with reasonable returns and dividends, is to investing in real estate investment trusts (REITs). A REIT can provide you with the addition of real estate to your investment portfolio without requiring you to come up with a large amount of capital. Plus, REITs pay out dividends.

Brief Overview of REITs

Real estate investment trusts are basically collections of real estate investments. They can be public or private in nature, and the publicly held REITs are traded on stock exchanges much like stocks. This makes them easy to purchase. REITs can include commercial or residential real estate investments, as well as investments in real estate related assets such as storage companies and mortgage providers.

REITs are desirable because of their tax structure; corporations formed them originally with the intent to create a tax benefit. Because of the tax treatment REITs enjoy, they are required to pay 90% of their taxable income out to investors. This means that, in some cases, the dividend yield can be quite generous.

Investing in REITs

Whenever you choose dividend investments, you need to be careful about your efforts, and do your research. This is especially important as you consider REITs. The climate following the relatively recent mortgage market meltdown and the financial crisis of 2008 means that many REITs have been hit pretty hard. They have lost value, and some of them have cut their dividend payouts.

This state of affairs means that there are some great deals to be had, allowing you to find REITs at very reasonable prices. However, you do need to be careful. As you would with any dividend stock, investigate the merits of the REITs you are considering before you decide to invest:

  • Consistent dividend performance: Look at the dividend performance of the company. Look at the pattern of dividend payouts and increases. Consider that solid companies have regular performance, and regular increases. During times of trouble, the prudent REIT doesn’t need to cut dividends as much. Look back: There are some REITs that have been less affected by global real estate market setbacks than others. While future performance can’t be guaranteed by the past, the past can, nevertheless, provide some insight.
  • Reasonable expectation for growth: Look at the holdings of the REITs in question. Is there reasonable expectation for growth? Consider whether or not the REITs you are researching offer the potential for earnings growth as the current economic situation improves. A REIT heavily invested in subprime mortgages might not be your best option, but a REIT that has a reasonable expectation of earnings because of more prudent assets might not be a bad choice.

Now might be a good time to consider REITs. With the US economy, and the global economy, showing some symptoms of recovery, it is possible that real estate could also see some amendment. If this is the case, the REITs in your dividend portfolio could allow you to see regular income – and an increase in that income – as the situation improves.

Reading the Balance Sheet: Liabilities and Shareholder Equity

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When choosing a dividend stock for your portfolio, it is important to consider your options, including the health of the company and what its balance sheet looks like. Recently, we considered the side of the balance sheet containing a company’s assets. Now it’s time to look at the other side of the balance sheet – the side containing liabilities.

Company Liabilities

Assets are those items that contribute value to a company. Assets provide value that can provide funding to the business. Liabilities, though, are obligations to others. This is usually money owed to other companies, or to suppliers, or for some other purpose. There are two main types of liabilities:

  1. Current: Current liabilities are those that are paid within the time period of one year. Accounts payable is one example of a current liability. A business normally has to discharge those obligations within a year. Additionally, long-term obligations that are paid within a year are also considered current. So the amount of the interest that is paid on a 20-year loan during the course of the year is considered a current liability.
  2. Long term: A long-term liability is one that does not need to be paid until after a year. This can include non-debt financial obligations, such as an agreement to pay a certain amount of money for a shipment of goods at a later date, as well as debt obligations.

Company liabilities offset the assets, since they represent a drain on the resources of a company.

Shareholder Equity

Interestingly enough, shareholder equity actually goes on the same side of the balance sheet as liabilities. Shareholder equity represents the amount of money invested in the business at the outset. Shareholder equity can increase if the company decides to take some of its earnings and invest them back into the company.

When reading a balance sheet, you will find it divided into two sides. On side the assets will be listed, and on the other side the liabilities and shareholder equity will be listed. As the name “balance” sheet implies, the two sides are supposed to even out. The assets a company has should equal the liabilities plus shareholder equity, and you should see how that comes about. If a balance sheet doesn’t balance, it’s important to look into the numbers to find out why.

As you look at the balance sheet, compare the two sides. You will have an idea of what the company owns, and what its obligations are. If a company appears to be highly leveraged, with lots of debt in comparison to assets, you know that the company is risky. A balance sheet can provide clues about how a company uses money, and that, in turn, can help you decide whether or not to include the investment in your dividend portfolio.

Reading the Balance Sheet: Assets

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When researching dividend stocks, and determining which are solid picks for your investment portfolio, it can help to understand the balance sheet. Take a look at a company’s balance sheet to get an idea of the financial stability of the company before investing. A company that is financially stable is more likely to be able to raise dividends over time, helping you improve your portfolio over all.

You will look at different items on a balance sheet, including assets, liabilities and shareholder equity. Right now, we will look at assets; next week we will tackle liabilities and shareholder equity. Assets, when considering companies, are used to operate the business.

Current Assets

These are assets that can be converted quickly and easily into cash. For the most part, current assets have a life span of a year or less. Cash is, unsurprisingly, the most popular of current assets. Additionally, there are “cash equivalents,” like U.S. Treasuries, that are considered pretty much as good as cash, and that can be liquidated quickly.

Other types of current assets, though, might be accounts receivable – when clients owe money – as well as inventory. Inventory can include ready-made products that company plans to sell, as well as raw materials that will be used to create products and different items in various stages of manufacture.

Non-Current Assets

Those assets that cannot be turned into cash quickly and easily, and which have a longer lifespan, are called “non-current.” These assets are usually considered long-term and tangible. Machinery the company uses, real estate (warehouse, store or land), and other equipment, such as office equipment like computers, phones and chairs, are considered non-current assets.

However, while many non-current assets are tangible, there are those that are not. Patents and copyrights are considered non-current assets. The value of such intellectual property can be incalculable, and should be considered as you estimate the value of a company.

Depreciation

Another consideration is the depreciation of assets over time. During the useful life of an asset, it slowly loses some of its value. It is important to factor in the economic cost of the declining value of assets as you consider company. On the balance sheet, depreciation is deducted from the assets as part of the process of figuring value.

In the end, you need to understand what the company has that is of value. You want to choose dividend stocks that will remain solid over time, and possible show a tendency to grow. A number of assets can prove that the company has sufficient items of value to remain in business – and possibly even grow.

Planning Qualified Dividend Purchases

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One of the current benefits dividend investors can receive right now is the ability to receive favorable tax treatment on qualified dividends. Until the end of 2012 (unless Congress makes changes), it is possible to have certain dividends taxed at the long-term capital gains rate.

The current long term capital gains rate (again, extended through 2012) caps at 15%. For those in the lowest tax brackets, there is no tax at all on long term capital gains. Short term capital gains, though, are taxed at your regular income rate. Non-qualified dividends are also taxed at this rate. This means that, if you are in the 28% tax bracket, your non-qualified dividends will be taxed as ordinary income. With the proper planning, though, you can ensure that most of your dividends are qualified – paying no more than 15% on your dividend income, no matter your income bracket.

Making Sure Your Purchases are Qualified

If you want to be able to claim your dividends as qualified, you need to own the stock or mutual fund in question for more than 60 days in the 121 days preceding the 60 days before the ex-dividend date. This means that you need to think carefully about when you buy shares if you want the tax favored status that comes with qualified dividends.

Before you purchase a share of a company or a mutual fund, find out when the dividend will be paid out. With a company, you can use the ex-dividend date as your guide, or you can simply make your purchase after the dividend has been distributed.

The same is true of buying mutual fund shares. Look at the fund’s distribution schedule and find out when dividends and capitals gains are normally distributed. Make your purchase just after a distribution takes place. This way, you will be able to ensure that you meet the definition of “qualified,” and receive the long term capital gains rate as you pay taxes on your income.

Paying Taxes on Reinvested Dividends

It’s important to realize, too, that you will pay taxes on reinvested dividends. Even though you don’t receive the cash in hand, it is still considered income by the IRS. So take this into account when purchasing shares in a new company or mutual fund. Just because you plan to have the dividends automatically reinvested doesn’t mean you are protected from paying taxes. The only way to avoid it right now is if your dividend investments are held in a tax advantaged retirement account.