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Forget saving money! I’d rather buy REITS to generate a growing passive income

While living within your means is a great first step to take when seeking to improve your personal finances, failing to obtain a relatively high return on your investments could hold back your plans to get rich and retire early.

Indeed, holding cash over the long run is unlikely to produce high returns once inflation is factored in. This could mean that the purchasing power of your investments gradually declines.

As such, investing in real estate investment trusts (REITs) could be a worthwhile move. Not only do they offer higher income returns than cash in many cases, they also have the potential to deliver capital growth while reducing risk through diversification.

Income potential

Historically, cash has been an inefficient use of capital. Businesses, individuals and investment managers have usually sought to minimise their exposure to cash in order to avoid the drag it causes on overall returns. As such, with interest rates being at relatively low levels when compared to their historic average, now could be an even more important time to avoid the opportunity cost that holding cash entails.

REITS have historically offered above-inflation income returns. Even though property prices have increased across the globe since the financial crisis, it is possible to obtain a dividend yield from REITs that is higher than that offered by cash. Since interest rates are expected to remain suppressed over the medium term due in part to global economic risks posed by a trade war between China and the US, the difference in income returns between REITs and cash could remain relatively wide.

Growth prospects

While cash offers no prospect of generating a capital return, REITs could deliver growth over the long run. For example, with the global economy continuing to produce relatively encouraging GDP growth despite the risks posed by a global trade war, there may be opportunities for rent rises. This could feed through into higher dividends for investors in REITs.

Similarly, REITs may offer capital growth potential. Although property prices are relatively high in some geographies after a period of strong growth in the years following the financial crisis, recent data has suggested that a pullback has taken place in a number of regions. This could mean that property prices are more attractive, which may produce improving total returns for investors in REITs.

Risk/reward

Clearly, investing in a REIT is riskier than holding cash. However, this risk is mitigated to a large extent by the diversity that a REIT offers. Although some REITs may be more diverse than others in terms of the types of property they hold, their range of assets and the locations they cover can mean that risks such as extended void periods are significantly reduced.

Therefore, on a risk/reward basis REITs appear to be more appealing than cash. Over the long run they could produce higher income returns, as well as the prospect of capital growth.

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The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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