Collecting Rent From Stocks 101

Collecting rents from the stock market is easy. Income property ownership when purchased properly, so it generates a positive cash flow, can be a solid investment that over time produces wealth and pride of ownership.  Real estate is something tangible or a physical asset that can be touched and seen verses a share of stock that sits in an investment account. In a unique manner there is a way to use the income property investment model for real estate within stock ownership. The strategy involves using dividends as part of the investment, yet treating the set up a lot like an apartment building.

Real estate income property involves owning a piece of real estate that is rented out to one or multiple tenants that pay rent.  Income stock investing involves owning a company or multiple company’s that pay dividends to the holders of their stock. Both strategies require an investment that provides yearly income returns to the investor.  This is the basics of collecting rents strategies, so let’s talk about the details and comparison of both various categories.

Collecting Rents Comparison

Principal Value Fluctuation:  Both assets, real property and stock, require an investment of capital at a certain purchase value.  Most will say that stocks fluctuate more than real estate. Yet, real estate investor’s on the most part seem to only care what the value of their real estate is upon the day of purchase or the day they put it up for sale. In essence they don’t really care to much about worth, since they care about the income.  Using this concept with income generating stocks works as well. Take the daily market out of your investment thoughts and only be concerned with the income (or rents) that the stock is producing.

collecting rent

Tenant Monitoring:  Income property owners are always concerned with the financial stability of their tenants, and the potential tenant’s ability to pay rent on time and not default in the future. Dealing with evictions or collecting rents is a headache and requires time. So it is always advisable to pay for credit checks, and do background checks prior to renting to a new tenant. All to reduce the risk of a dead beat tenant that will end up not paying us rent, or providing us with the income that we want from our investment.

With stocks all companies are required to provide us with their financial statements and reports every quarter.  The infomation within these reports are governed by the SEC and available to everyone. You can even tune into the quarterly conference call with the bosses of these companies to hear what they are doing and planning.  Even better every year the company will normally provide an annual report with extensive detailed information as to their activities and plans. Many companies have an investor relations department that will answer questions that you may have.  No credit checks, no criminal checks, and all their history is there every quarter.

Annual Income Growth:  The idea behind any income investment is to grow the annual income. This produces more cash flow for the owner and makes the investment more valuable over time. What I hear from small income property owners is that it is difficult to raise rents consistently for they are in fear of losing the tenant and having to incur all the costs and time required to re-rent the property.  Even when landlords are able to raise the rents usually getting a three to five percent increase is challenging.

Within the stock market there are companies that have consistently raised their annual dividend payments to their shareholders for more than twenty-five years, and a few that have consistently done this over fifty years.  Some examples would be Coca-Cola, 3M, and Wal-Mart. A five to ten percent increase isn’t uncommon. The range can be less than five percent and higher than fifteen or twenty percent at times depending on the business.

Maintenance Expense:  In real estate this is a given.  Things wear out. Appliances, carpert, plumbing, and more.  This is part of real estate ownership. With income stock investing there is none of this.

Liquidity:  Real estate is not a liquid investment.  It can take time and lots of money to get rid of the property.  With an investment in stocks it’s a matter of placing a sell order and paying a small fee.  Much better liquidity. The draw back to liquidity is that it requires emotional discipline to own.

Taxes:  With rental properties it flows to you as income that you incorporate into your taxes.  The one major benefit of real property is that you can depreciate the asset over time and reduce your taxable income that you have to pay on.  Investment stocks don’t have the benefit of depreciation, but they do have the benefit of paying a lower tax rate for qualified dividends.

Capital Allocation:  Real estate requires putting up your capital all at once in order to capture the investment.  With income stock investing you have the choice of allocating capital in small incraments, or building your income stock property one unit at a time.

Here’s the 101 to this concept:  First choose the number of tenants you want to have in your property, so let’s say it’s an ten unit property. You’ll have ten stocks that you will treat as your tenants.  Your tenants must pay you rent, so this means your tenant must pay annual dividends. I recommend that all of your tenants are in separate industries, so you won’t have two oil companies as an example in case one industry comes upon challenges.  

You want stocks that are established businesses that have a durable competitive advantage. This means the business makes a product, has a service, or has systems or locations that would be impossible or very difficult to duplicate, and will be around for the next ten years.  Ten years is important, because it will get you through a weak economic cycle, and force you to determine weather the product or service offered by the business could become obsolete. This is the hardest part, because no one has a crystal ball for the future.

You want your tenants to have a strong financial ratings. You can determine this on your own or use an outside rating agency like Standard & Poors. I prefer to spend time analyzing the business’s financials at this point. Find a list of items that are important to our. After you have you list of ideal tenants decide on a price that you want to pay for each stock.  Getting a fair price is important in order to create value.

Monitor your tenants at least a year. You can do this a number of ways, but the most efficient way is to focus on the rent that the tenant is paying and what portion of the rent they are paying you related to their overall cash flow.  This dividend pay out portion to their cash flow is called the payout ratio. If the ratio of payout to cash flow exceeds over 60% this is can be a red flag depending on the type of business and the amount of cash it generates.  Either way it’s a good place to draw the line in the sand.

If the business also doesn’t raise their dividend payout annually or they even cut it this could be a red flag as well. If a red flag pops up I investigate as to why there is a problem and what is the business’s plan to fix it or if it is even fixable.  I asses at that point if I will do anything or wait it out. Remember your goal is to have long term financially healthy tenants that take care of their business. As in owning income real estate changing tenants out is time consuming and can be costly, so be diligent on choosing your tenants.  

collect rent

The point I am trying to make here is that perception is a big part of success in investing.  Yet if you find the right path with the right perception you can avoid all of that and make money using a strategy that has served real estate investment investors for years and is perceived as a great strategy.  The great benefit of this thinking is that you can start investing and collecting income with much smaller sums of money than would be required with real estate.

If you’re an beginner investor check out 7 Skillful Steps for Investoring Beginners for more pointers.