Investing in Real Estate Investment Trusts (REITs)
With REIT investing, you gain access to income-producing properties without having to own those properties outright. REITs may own several different kinds of properties (e.g. commercial, residential, storage) or focus on just one or two market segments.
Real estate investment trusts or REITs can be a great addition to a portfolio if you’re hoping to diversify. REIT investing might appeal to experienced investors as well as beginners who are looking to move beyond stocks and bonds.
Key Points
• REITs provide a way to invest in income-producing real estate without owning the properties directly.
• REITs must distribute at least 90% of taxable income to shareholders as dividends.
• Types of REITs include equity, mortgage, and hybrid, each with different investment focuses.
• Investing in REITs can be done through shares, mutual funds, or ETFs, available via brokerages.
• Benefits of REITs include potential for high dividends and portfolio diversification, while risks involve liquidity and sensitivity to interest rates.
What Is a REIT?
A REIT is a trust that owns different types of properties that generate income. REITs are considered a type of alternative investment, because they don’t move in sync with traditional stock and bond investments.
Some of the options you might find in a REIT can include:
• Apartment buildings
• Shopping malls or retail centers
• Warehouses
• Self-storage units
• Office buildings
• Hotels
• Healthcare facilities
REITS may focus on a particular geographic area or property market, or only invest in properties that meet a minimum value threshold.
A REIT may be publicly traded, meaning you can buy or sell shares on an exchange the same as you would a stock. They can also be non-traded, or private. Publicly traded and non-traded REITs are required to register with the Securities and Exchange Commission (SEC), but non-traded REITs aren’t available on public stock exchanges.
Private REITs aren’t required to register with the SEC. Most anyone can invest in public REITs while private REITs are typically the domain of high-net-worth or wealthy investors.
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How Do REITs Work?
With REIT investing individuals gain access to various types of real estate indirectly. The REIT owns and maintains the property, collecting rental income (or mortgage interest).
Investors can buy shares in the REIT, which then pays out a portion of the collected income to them as dividends.
To sum it up: REITs let investors reap the benefits of real estate investing without having to buy property themselves.
REIT Qualifications
Certain guidelines must be met for an entity to qualify as a REIT. The majority of assets must be connected to real estate investment. At least 90% of taxable income must be distributed to shareholders annually as dividend payouts.
Additionally, the REIT must:
• Be organized in a way that would make it taxable as a corporation if not for its REIT status
• Have a board of trustees or directors who oversee its management
• Have shares that are fully transferable
• Have at least 100 shareholders after its first 100 as a REIT
• Allow no more than 50% of its shares to be held by five or fewer individuals during the last half of the taxable year
• Invest at least 75% of assets in real estate and cash
• Generate at least 75% of its gross income from real estate, including rents and mortgage interest
Following these rules allows REITs to avoid having to pay corporate tax. That benefits the REIT but it also creates a secondary boon for investors, since the REIT may be better positioned to grow and pay out larger dividends over time.
Types of REITs
The SEC classifies three categories of REITs: equity, mortgage, and hybrid. Each type of REIT may be publicly traded, non-traded, or private. Here’s a quick comparison of each one.
• Equity REITs own properties that produce income. For example, an equity REIT might own several office buildings with units leased to multiple tenants. Those buildings generate income through the rent the tenants pay to the REIT.
• Mortgage REITs don’t own property. Instead, they generate income from the interest on mortgages and mortgage-backed securities. The main thing to know about mortgage REITs is that they can potentially produce higher yields for investors, but they can also be riskier investments.
• Hybrid REITs own income-producing properties as well as commercial mortgages. So you get the best (and potentially, the worst) of both worlds in a single investment vehicle.
Aside from these classifications, REITs can also be viewed in terms of the types of property they invest in. For example, there are storage-unit REITs, office building REITs, retail REITs, healthcare REITS, and more.
Some REITs specialize in owning land instead of property. For example, you might be able to own a stake in timberland or farmland through a real estate investment trust.
How Do REITs Make Money?
REITs make money from the income of the underlying properties they own. Again, those income sources can include:
• Rental income
• Interest from mortgages
• Sale of properties
As far as how much money a REIT can generate, it depends on a mix of factors, including the size of the REIT’s portfolio, its investment strategy, and overall economic conditions.
Reviewing the prospectus of any REIT you’re considering investing in can give you a better idea of how it operates. One thing to keep in mind with REITs or any other type of investment is that past performance is not an indicator of future returns.
How to Invest in REITs
There are a few ways to invest in REITs if you’re interested in adding them to your portfolio. You can find them offered through brokerages and it’s easy to open a trading account if you don’t have one yet.
REIT Shares
The first option for investing in REITs is to buy shares on an exchange. You can browse the list of REITs available through your brokerage, decide how many shares you want to buy, and execute the trade. When comparing REITs, consider what it owns, the potential risks, and how much you’ll need to invest initially.
You might buy shares of just one REIT or several. If you’re buying multiple REITs that each hold a variety of property types, it’s a good idea to review them carefully. Otherwise, you could end up increasing your risk if you’re overexposed to a particular property sector.
REIT Funds
REIT mutual funds allow you to own a collection or basket of investments in a single vehicle. Buying a mutual fund focused on REITs may be preferable if you’d like to diversify with multiple property types.
When researching REIT funds, consider the underlying property investments and also check the expense ratio. The expense ratio represents the annual cost of owning the fund. The lower this fee is, the more of your investment returns you get to keep.
Again, you can find REIT mutual funds offered through a brokerage. It’s also possible to buy them through a 401(k) or similar workplace retirement plan if they’re on your plan’s list of approved investments.
REIT ETFs
A REIT exchange-traded fund (or ETF) combines features of stocks and mutual funds. An ETF can hold multiple real estate investments while trading on an exchange like a stock.
REIT ETFs may be attractive if you’re looking for an easy way to diversify, or more flexibility when it comes to trading.
In general, ETFs can be more tax-efficient than traditional mutual funds since they have lower turnover. They may also have lower expense ratios.
Benefits and Risks of REITs
Are REITs right for every investor? Not necessarily, and it’s important to consider where they might fit into your portfolio before investing. Weighing the pros and cons can help you decide if REITs make sense for you.
Benefits of REITs
• Dividends. REITs are required to pay out dividends to shareholders, which can mean a steady stream of income for you should you decide to invest. Some REITs have earned a reputation for paying out dividends well above what even the best dividend stocks have to offer.
• Diversification. Diversifying your portfolio is helpful for managing risk, and REITs can make that easier to do if you’re specifically interested in property investments. You can get access to dozens of properties or perhaps even more, inside a single investment vehicle.
• Hands-off investing. Managing actual rental properties yourself can be a headache. Investing in REITs lets you reap some of the benefits of property ownership without all the stress or added responsibility.
• Market insulation. Real estate generally has a low correlation with stocks. If the market gets bumpy and volatility picks up, REITs can help to smooth the ride a bit until things calm down again.
💡 Quick Tip: It’s smart to invest in a range of assets so that you’re not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.
Risks of REITs
• Liquidity challenges. Buying REIT shares may be easy enough, but selling them can be a different matter. You may need to plan to hold on to your shares for a longer period than you’re used to or run into difficulties when trying to trade shares on an exchange.
• Taxation. REIT investors must pay taxes on the dividends they receive, which are treated as nonqualified for IRS purposes. For that reason, it might make sense to keep REIT investments inside a tax-advantaged IRA to minimize your liability.
• Interest rate sensitivity. When interest rates rise, that can cause REIT prices to drop. That can make them easier to buy if the entry point is lower, but it can make financing new properties more expensive or lower the value of the investments the REIT owns.
• Debt. REITs tend to carry a lot of debt, which isn’t unusual. It can become a problem, however, if the REIT can no longer afford to service the debt. That can lead to dividend cuts, making them less attractive to investors.
The Takeaway
REITs can open the door to real estate investment for people who aren’t inclined to go all-in on property ownership. REITs can focus on a single sector, like storage units or retail properties, or a mix. If you’re new to REITs, it’s helpful to research the basics of how they work before diving into the specifics of a particular investment.
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FAQ
How do I buy a REIT?
You can buy shares of a REIT through a broker if it’s publicly traded on an exchange. If you’re trying to buy shares of a private REIT, you can still go through a broker, but you’ll need to find one that’s participating in the offering. Keep in mind that regardless of how you buy a REIT, you’ll need to meet minimum investment requirements to purchase shares.
Can I invest $1,000 in a REIT?
It’s possible to find REITs that allow you to invest with as little as $1,000 and some may have a minimum investment that’s even lower. Keep in mind, however, that private or non-traded REITs may require much larger minimum investments of $10,000 or even $50,000 to buy in.
Can I sell my REIT any time?
If you own shares in a public REIT you can trade them at any time, the same way you could a stock. If you own a private REIT, however, you’ll typically need to wait for a redemption period to sell your shares. Redemption events may occur quarterly or annually and you may pay a redemption fee to sell your shares.
What is the average return on REITs?
The 10-year annualized return for the S&P 500 United States REIT index, which tracks the performance of U.S. REITs, was 2.34%. Like any sector, however, REITs have performed better and worse over time. Also, the performance of different types of REITs (self-storage, strip malls, healthcare, apartments, etc.) can vary widely.
About the author
Rebecca Lake
Rebecca Lake has been a finance writer for nearly a decade, specializing in personal finance, investing, and small business. She is a contributor at Forbes Advisor, SmartAsset, Investopedia, The Balance, MyBankTracker, MoneyRates and CreditCards.com. Read full bio.
Photo credit: iStock/ozgurcoskun
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