Buying Real Estate Investment Trust (REIT) is one of the several ways one can invest in real estate. REITs are a key consideration when constructing any equity or fixed-income portfolio. They provide a way for you to invest in real estate property without actually buying and managing those properties yourself.
Investing in real estate by buying REITs can diversify your portfolio, but not all REITs are created equal. Some REITs invest directly in properties, earning rental income and management fees. Others invest in real estate debt, i.e. mortgages and mortgage-backed securities.
Moreover, one of the biggest benefits REITs have to offer is their high-yield dividends, although they tend to focus on a specific sector of properties, for instance, retail or shopping centers, hotels, and resorts, or healthcare and hospitals. Continue reading to learn more about REITs.
Meanwhile, this article will explain everything you need to know about real estate investment through REITs, including the types of Real estate investment trusts, how to invest in REITs, pros and cons, and more.
What is a Real Estate Investment Trust (REIT)?
A REIT is a company that owns and typically operates income-producing real estate or related assets. REITs own many types of commercial real estate, these may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans.
Moreover, unlike other real estate companies, a REIT does not develop real estate properties to resell them. Instead, a REIT buys and develops properties primarily to operate them as part of its investment portfolio. Some REITs engage in financing real estate. However, these real estate companies have to meet several requirements to qualify as REITs. Most REITs trade on major stock exchanges, and they offer several benefits to investors.
Real estate investment trusts, just like a mutual fund provide a possibility for individuals to benefit from valuable real estate. REITs provide an investment possibility for every individual investor to earn a share of income or dividend produced from real estate without direct investment in any property. Furthermore, REITs invest in most real estate property types, including apartment buildings, cell towers, hotels, data centers, medical facilities, offices, warehouses, etc.
How do REITs Work?
Congress created REITs in 1960 as a way for individual investors to buy shares in large-scale commercial real estate portfolios, just as they could in other businesses.
REITs own and manage income-producing commercial real estate, whether it's the properties themselves or the mortgages on those properties. You can invest in the companies individually, through an exchange-traded fund, or with a mutual fund.
Moreover, there are many types of REITs available. Real estate investment trusts generally specialize in a specific real estate sector. But, diversified and specialty REITs may include multiple types of real properties in their portfolios.
Furthermore, a company is required to meet certain standards to qualify as a real estate investment trust:
- All REITs should at least have 100 shareholders or investors and none of them can hold more than 50% of the shares
- Must have at least 75% of its assets invested in real estate, cash, or treasuries
- 75% of its gross income must be obtained from real estate investments (rents, interest on mortgages that finance real property, or real estate sales)
- Be an entity that's taxable as a corporation
- Must pay dividends equaling at least 90% of their taxable income to shareholders
- Must be managed by a Board of Directors or Trustees
Types of REITs
Three types of REITs are categorized by their investment holdings. and they are as follows:
- Equity REIT: Equity REITs operate like a landlord. They own or operate income-producing real estate, such as office buildings and apartment complexes. They also provide upkeep of and reinvest in the property and collect rent checks — all the management tasks associated with owning a property.
- Mortgage REIT: Simply known as mREITS, don't own the underlying property. Instead, they own debt securities backed by the property. They provide financing for income-producing real estate either directly through mortgages and loans, or indirectly by buying mortgage-backed securities and earning income from the interest on the investments.
- Hybrid REITs: These are a combination of both equity and mortgage REITs. These businesses own and operate real estate properties as well as own commercial property mortgages in their portfolio. These REITs use the investment strategies of both equity and mortgage REITs. Revenue comes from both rent and interest income.
Moreover, real estate investment trusts are also classified into three based on how their shares are traded:
- Publicly Traded REIT: These are REITs that are registered with the SEC but do not trade on the national stock exchange. Liquidity may be limited in these types of REITs. They are traded on an exchange like stocks and ETFs and are available for purchase using an ordinary brokerage account. Shares of publicly-traded REITs are listed on a national securities exchange, where they are bought and sold by individual investors.
- Public Non-Traded REITs: Are also registered with the SEC but they are traded on the stock exchanges. They are more stable than publicly-traded REITs. This is because they are not affected by market fluctuations.
- Private REIT: Private REITs are exempt from SEC registration and don’t trade on national stock exchanges. These can typically only be sold to institutional investors.
How to Invest in Real Estate Investment Trust (REIT)
An individual may buy shares in a REIT, which is listed on major stock exchanges, just like any other public stock. You can also buy shares in a REIT mutual fund or exchange-traded fund (ETF). Buying a REIT ETF or mutual fund may provide more liquidity than buying traditional REIT shares.
Private REITs are more complicated. They typically are limited to institutional investors and accredited investors who can directly access the funds or reach them through private networks. Moreover, they also usually carry much higher minimum investment requirements and can be much harder to offload. Investors also have the ability to invest in public non-listed REITs and private REITs.
Pros and Cons of Buying REITs
Moreover, just like any other investment, there are also advantages and disadvantages of investing in a Real estate investment trust.
Here are the benefits of investing in a REIT
- Transparency: REITs traded on major stock exchanges operate under the same rules as other publicly listed securities for regulatory and reporting purposes.
- Liquidity: Shares can easily be sold and bought in the market. This is a good advantage as buying and selling real estate often takes time.
- High Dividends Yield: REITs provide a stable income stream for investors, as 90% or more of the profits are returned to them.
- Diversification: Moreover, having a REIT in an investment portfolio is an advantage when other stocks or securities are down because REITs usually have a low correlation to the performance of other asset classes.
- Performance: REITs are historically proven to be performance-wise due to the steady long-term appreciation of commercial properties.
Here are some of the risks of investing in REITs
- Low growth: Only 10% can be reinvested back into the business since 90% of the profit is given back to investors.
- Higher tax payment: REIT dividends are taxed the same as regular income instead of the 15% rule that most dividends fall under.
- Investment risk: factors such as property valuation, interest rates, debt, geography, and tax laws; may affect the real estate market, and REITs prices fall.
- High management fees: some REITs charge high transaction and administrative fees, which tend to lessen the net payout to investors.
- Less control: investors can’t control operational decisions, such as the ownership of properties and the strategies applied to market trading.
REITs can be a good addition to your portfolio because they often perform independently of stock and bond markets. This can make them a good diversifier for your asset allocation.
Furthermore, REITs can provide income to investors looking for cash flow as they typically pay high dividends. Moreover, they offer an opportunity for investors who want to get involved in large-scale real estate investments without the hassle of individual purchases.
In conclusion, beware of anyone who attempts to sell REITs that are not registered with the SEC. You can also verify the registration of both publicly traded and non-traded REITs through the SEC’s EDGAR system.