New Tax Law May Not Be the Only Reason to Pay Heed to REITs

Advice to the Advisors

Cityscape for REITs and New Tax Law Savings | Sheaff Brock Institutional Group

New Tax Law May Not Be the Only Reason to Pay Heed to REITs

Remarking on the fact that the Tax Cuts and Jobs Act is set to deliver over a trillion dollars in tax savings over the next decade, adding fuel to an already healthy economy, those tax savings can stand to generally improve the tax efficiency of REITs and other real asset investments,” JR Humphreys, portfolio manager of the Sheaff Brock Real Estate Income & Growth strategy posits.

One of the central features of the tax bill is a 20% deduction on pass-through income. By law, REITs must distribute at least 90% of their income. And, since the REITs themselves do not pay tax on distributed income, those tax savings are passed on to the investors. In fact, as Rebecca Lake points out in U.S. News, shareholders may be able to deduct that 20%, even if they don’t itemize deductions on their federal tax returns. (Needless to say, investors should consult their own tax advisors before drawing conclusions about the impact of the tax rules in each individual case.)

In addition to the favorable tax treatment on REIT distributions, Humphreys offers insight into several other factors that appear to bode well for investors in REITs:

  1. In the past few quarters, many investors, fearful of a rising interest rate environment, avoided REITs, equating them with fixed-income investments such as bonds.
  2. In the wake of recent merger and acquisitions, private equity firms have been very active in property acquisition. In fact, reduced corporate tax rates may have the effect of increased economic activity, which has the potential of increasing the demand for real estate.
  3. Many REITs can trade at a discount to NAV, meaning for less than the group of actual properties in the REIT are worth.

Given all these factors, just why is it that more advisors don’t tend to recommend to clients that they include Real Estate Investment Trusts in their portfolio mix? Could it be the challenge of adapting traditional stock research methodology to the different business model and different financial statements of REITs?

As a first step to aid advisors to feel more confident including REITs, Sheaff Brock makes use of the targeted fundamental research done by Revelation Investment Research, Inc.’s REIT Forecaster. The Forecaster ranks the long-term relative return prospects of the approximately 160 Equity REITs in the MSCI USA Investable Market Index, creating a composite score for each REIT, based on those attributes deemed most highly correlated to future returns.

Perhaps most significant, Humphreys stresses, is the Sheaff Brock Real Estate Income Portfolio’s emphasis on opportunities for long-term capital appreciation in addition to income. While companies are selected first with an eye to managing downside risk, the inclusion of property holdings in growth industries such as cellphone technology, warehousing in support of e-commerce, and greenhouse farming add upside potential. “We don’t look to mirror an index,” Humphreys explains.

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