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Why buying ASX REITs isn’t always as safe as houses

While investing in Australian real estate investment trusts (A-REITs) can be a great way to generate a strong dividend income for minimal work, as with any investment, it’s never risk-free.

In fact, when it comes to investing in A-REITs, the strong returns that you can generate from distributions reflect the extra risk that is taken when you decide to be a part of these investment vehicles.

A-REITs are equity REITs, meaning they own assets such as shopping centres or office blocks that then generate income by filling them with tenants.

Whether it’s Scentre Group (ASX: SCG) and its Westfield assets or National Storage REIT (ASX: NSR) with its self-storage facilities across the country, these A-REITs can often earn dividends that are comparable to the top ASX dividend stocks on the market.

Where does the risk come from?

While you might think that buying and holding a portfolio of investment properties is easy money, the reality is that it’s not that simple when investing in A-REITs.

A-REITs are able to generate strong returns for investors by using significant amounts of leverage to buy these commercial or residential properties, which boosts their own cash-on-cash returns.

However, the basics of finance tell us that with more leverage comes higher risk (and higher returns) and A-REITs are therefore often using smaller equity buffers to build out their portfolios.

This can be especially true with commercial real estate REITs such as Lendlease Group (ASX: LLC), which scrapped a planned $500 million bond issuance amid significant impairments of its engineering division in November 2018.

In other words, these A-REITs can often be a great investment until they’re not, as there has been a tendency for REITs in markets across the globe to very quickly turn from profitable to bankrupt and leave shareholders wondering where their money went.

Should you buy A-REITs in 2020?

While it’s good to be aware of the risks involved in any investment, the reality is that investors in many of the A-REITs on the market have seen strong returns over the last decade or so.

While Aussie retail is showing signs of slowing, record-low interest rates have lowered the cost of borrowing and boosted property prices higher in the most recent quarter.

Overall, I think A-REITs can still deliver a strong dividend income in the next 18 months or so and could prove to be a strong buy for those looking to boost their earnings.

If you’re looking outside of the real estate sector, I’d suggest checking out these 3 ASX income stocks before the year is out.

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Motley Fool contributor Kenneth Hall has no position in any of the stocks mentioned. The Motley Fool Australia has recommended National Storage REIT and Scentre Group. 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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