Investors need to understand the differences between these income-producing stocks.
Investing in dividend stocks is a great way to build wealth over the long term. But income investors often face difficult choices. Should you invest in real estate investment trusts (REITs), which offer higher yields but less capital appreciation, or traditional dividend stocks, which offer lower yields but higher growth potential?
What is a REIT?
REITs operate a simple business model. They buy properties, rent them out, and split the rental income 50-50 with investors. They must pay out at least 90% of their taxable income as dividends to investors.
Most REITs fall into one of two categories: gross leases and net leases. Gross lease REITs offer comprehensive rental agreements in which the landlord pays most of the operating costs (taxes, insurance, utilities) associated with the property. Although net lease REITs have low rents, they do not cover operating costs.
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There are currently 13 categories of REITs: Office, Retail, Industrial, Residential, Hotels and Resorts, Healthcare Facilities, Data Centers, Self-Storage, Timber, Infrastructure, Mortgage, Specialty REITs, and General REITs.
Some of these sectors are more recession-proof than others, while others, such as data center REITs, can also benefit from long-term growth in other markets. Therefore, when choosing a REIT, investors should carefully evaluate the financial health of its core tenants and check whether they have maintained high occupancy rates over the past several decades.
for example, real estate income (oh -0.17%) One of the country’s most well-known net lease REITs, the company has maintained an occupancy rate of over 96% over the past 30 years. Additionally, the company has paid a consecutive monthly dividend since its founding in 1969, and has increased its dividend 124 times since its listing in 1994.
What are traditional dividend stocks?
Companies that are not REITs do not have to pay out most of their profits as dividends. Instead, you can choose to pay out a portion of your profits or free cash flow (FCF) as dividends.
But they usually don’t do that unless the business is mature. That’s because growing companies typically reinvest profits and FCF into business expansion, rather than simply returning that cash to investors.
This is why many high-dividend stocks are found in low-growth sectors such as consumer staples, banking, energy, utilities, and pharmaceuticals. However, even good companies may find it difficult to raise their dividends every year due to economic downturns. So to find the most resilient companies, investors should take a closer look at Dividend Kings that have raised their dividends every year for at least 50 years.
Instead of paying dividends, many companies will buy back their own shares, increasing the value of their remaining shares. By comparison, REITs typically raise more cash and dilute their own stock to purchase more real estate.
The companies that pay the most dividends continually grow revenue and profits, buy back their own stock, and increase their annual dividends. Here are reliable income generating plays that tick all these boxes. procter and gamble (PG -0.78%)is a major consumer staples company that has raised its dividend every year for 67 consecutive years.
Which is a better investment: REITs or dividend stocks?
Over the long term, a basket of high-dividend stocks can outperform a basket of REITs. The reason is simple. REITs dilute their own stock to raise more cash, are designed to generate stable income rather than capital appreciation, and generate higher profits. They are more sensitive to interest rates than diversified companies. Top dividend-paying companies consistently increase earnings per share to support their dividends, and that cycle should drive share prices higher.
To see the difference, let’s compare the total returns over 10 years. Schwab US REIT ETF (SCHH -0.05%)owns over 100 of America’s top REITs. Vanguard High Dividend Yield ETF (VYM -0.20%)owns over 500 high-dividend stocks in the market.
Source: YCharts.
Therefore, for many young investors, it may make more sense to invest in a basket of lower-yielding growth stocks than in high-yield REITs. However, for an older investor looking for passive income and not planning to reinvest dividends, REITs may offer a higher yield than fixed income investments such as his CDs or bonds.
So choosing between REITs and other dividend stocks depends on your risk tolerance and investment horizon. I personally combine REITs, dividend stocks, and CDs in my income-producing portfolio, but I believe that investors simply need to understand the differences rather than pegging one as the best choice. We believe that there is.
