In the past, real estate investing was only accessible to the affluent. However, the advent of real estate investment trusts (REITs) has altered this perception.
Investing in real estate through a REIT eliminates the need for purchasing and managing properties individually. This can be a smart way to branch out from the stock market and diversify your investments, yet it’s important to note that economic downturns may still affect your returns.
In this piece, we’ll explore the advantages and disadvantages of REITs and guide you on how to embark on this investment journey.
What is a REIT?
A real estate investment trust (REIT) is a company that owns and operates income-generating real estate. A group of investors will pool their money together to invest in a REIT, which makes it possible for you to earn rental income from real estate without buying and managing it yourself.
REITs invest in all sectors of the real estate market, including apartment buildings, hotels, retail locations, warehouses, and more.
Investing in REITs is popular due to its potential for a stable income and ease of buying and selling as most REITs are publicly traded. Additionally, the wide range of real estate sectors that REITs invest in adds to its appeal, providing investors with diverse investment opportunities.
To be recognized as a Real Estate Investment Trust (REIT) by the Internal Revenue Code (IRC), a company must adhere to several guidelines, such as:
- Offering shareholders a minimum of 90% of taxable income as dividends each year.
- Investing a minimum of 75% of its resources in real estate assets or cash.
- Generating at least 75% of its gross income through real estate rentals, mortgage interest, or sales.
- Being taxed as a corporation.
- Maintaining a board of directors or trustees.
- Having a minimum of 100 shareholders after its first year in operation.
- Limiting the ownership of its shares by no more than five individuals, with each holding no more than 50% of the total shares
The Pros and Cons of Investing in REITs
There are upsides and downsides to any investment decision, and REITs are no exception. If you’re on the fence about investing in a REIT, here are a few things you should consider first.
- Diversify your portfolio: Investing in a REIT is a good way to diversify your portfolio outside the stock market. And it allows you to invest in real estate without having to take on the risk of buying and managing the properties yourself.
- Steady stream of income: Many people are drawn to REITs for the steady dividend payments. By law, a REIT must distribute at least 90% of its taxable income to its shareholders.
- Less volatile investment: There is no such thing as a risk-free investment, but REITs do tend to be less volatile than the stock market.
- Liquid asset: Unlike physical real estate, REITs are a liquid investment and much easier to buy and sell quickly.
- Some REITs can be risky: Not all REITs are created equal and in particular, non-traded or private REITs are not as easy to sell.
- They can be expensive: To begin investing, some REITs require a minimum investment of $25,000.
- You may lose dividend payments: During an economic downturn, you could lose your dividend payments if the property stops producing adequate income.
Different Types of REITs
There are several kinds of REITs, depending on how the shares are bought and held. Here is an overview of the different types of REITs you can invest in.
Publicly-Traded Equity REITs
Publicly traded REITs are listed on a public stock exchange, such as the New York Stock Exchange (NYSE) or the NASDAQ. They are regulated by the U.S. Securities and Exchange Commission (SEC).
Individual investors can buy and sell REITs with an ordinary brokerage account. Publicly traded REITs tend to be more transparent and liquid than non-traded or private REITs.
Public Non-Traded REITs
A public non-traded REIT is listed with the SEC but is not listed on an exchange. They can only be purchased through certain types of brokers, and are much harder to buy and sell.
According to the SEC, it can also be much harder to determine the value of a non-traded REIT. Non-traded REITs don’t usually provide an estimate of the value per share until 18 months after the offering closes.
Private REITs are unlisted and aren’t typically regulated by the SEC. This makes them harder to value and a riskier investment. They also tend to be much more expensive, and often require a minimum investment of $25,000 or more.
An equity REIT operates like a landlord and owns income-producing real estate. The company manages the property, provides basic upkeep, and collects monthly rent payments.
A mortgage REIT doesn’t own the property but instead owns debt securities backed by the property. They collect the monthly payments, but someone else owns and manages the property. This tends to be a riskier investment than an equity REIT, but the shareholder dividends also tend to be higher.
A hybrid REIT is a combination of an equity and mortgage REIT. The company typically owns and operates both real estate properties and commercial real estate mortgages on its portfolio.
How do I invest in a REIT?
Investing in REITs can be done by buying individual REITs listed on public stock exchanges, or by investing in a REIT mutual fund or exchange-traded fund (ETF). The latter offers the advantage of exposure to real estate through a single investment, without the need to buy and manage individual REITs.
If unsure where to begin, seeking the guidance of a broker or financial planner can be helpful in finding the best investment option that suits your needs.
Is investing in a REIT the right choice for me?
Maybe, depending on your level of risk tolerance and financial goals. REITs do have a strong track record of growing dividends and long-term capital appreciation.
Many investors appreciate the steady form of income that a REIT can provide. And publicly traded REITs are regulated by the SEC and professionally managed, so they tend to be pretty transparent.
Many people are interested in investing in real estate but don’t have the time or money to buy and manage properties on their own. If you find yourself in this situation, REITs could be a suitable alternative for you.
With REITs, you can diversify your investment portfolio and reap the rewards of consistent dividend payments. Additionally, REITs tend to have high liquidity, making them a simpler investment than conventional real estate.
However, non-traded and private REITs can be more risky and opaque, so it’s crucial to thoroughly understand the investment before committing. If unsure, seeking guidance from a financial advisor can help determine the best approach for you.
Interested in learning about different types of REITs? Check out our full review of Fundrise to learn more.
Real Estate Investment Trust FAQs
What is a real estate investment trust (REIT)?
A REIT is a type of investment vehicle that owns and operates income-generating real estate properties. REITs allow individual investors to invest in a diversified portfolio of real estate assets. These include office buildings, apartments, shopping centers, and warehouses.
How do REITs generate income?
REITs generate income by owning and managing a portfolio of income-producing real estate assets, such as apartment buildings, hotels, office buildings, and retail spaces. These assets generate rental income, which is then distributed to REIT shareholders in the form of dividends.
Additionally, REITs can also generate income through the sale of real estate properties or by financing real estate developments, such as mortgage origination or securitization.
How are REITs different from other real estate investment options?
One aspect that sets REITs apart from other real estate investment options is their publicly traded nature. Many REITs can be found on stock exchanges, just like regular stocks, enabling individual investors to purchase and sell REIT shares with ease and agility. This allows individual investors to access real estate investments without the hassle of directly owning and managing properties.
Are REITs a good investment?
Investing in REITs can provide a lucrative opportunity for investors seeking to diversify their portfolio and earn passive income from the real estate market. However, as with any investment, REITs are not without their own set of risks.
It’s imperative to weigh the potential rewards against these risks before making a final investment decision. Researching the investment options available to you can help mitigate potential risks and maximize your chances of success.
What are the risks of investing in REITs?
Investing in REITs can be complex and entails potential risks. Key factors such as economic downturns, interest rate fluctuations, intense competition, subpar management, and limited liquidity can negatively impact REIT returns.
To safeguard your investments, it’s imperative to perform thorough market analysis and seek professional financial advice. This approach helps you establish your investment goals and risk appetite, enabling you to make well-informed decisions and potentially lower the risks associated with REIT investments.
Can REITs be held in a retirement account?
Yes, REITs can be held in a retirement account such as a traditional IRA, Roth IRA, or a 401(k).
Are REIT dividends taxable?
Yes, REIT dividends are generally taxable as ordinary income. However, REITs may also pay capital gains distributions, which are taxable at the capital gains rate.
How do I buy REITs?
REITs can be purchased through a brokerage account, just like stocks. You can place an order to buy REIT shares online, over the phone, or through a broker.
Can I buy REITs directly from the company?
While a few REITs offer the option to buy shares directly from the company, this is not a widespread practice. Typically, REITs are listed on stock exchanges and can only be acquired through a brokerage account.
Are REITs suitable for all investors?
REITs may not be suitable for all investors. Assess your financial aspirations, risk appetite, and investment timeline to determine if REITs align with your investment strategy. To make informed investment choices, it’s advisable to either seek advice from a financial expert or conduct extensive research.