Imagine being able to invest in real estate while gaining all of the pros in the market and few cons. You can skip the process of buying and maintaining a property yourself and just go straight to earning from real estate. This sort of investment bliss is what REIT offers.
To know how to invest in a real estate investment trust, you must be well informed of the industry/market. We have put together the information you need to get started and make proper decisions on your real estate investing.
What is REIT?
REIT as a word is pronounced reet to rhyme with sweet. It’s an acronym for Real Estate Investment Trust.
A Real Estate Investment Trust, REIT, is a company that owns, operates, or finances real estate – specifically income-producing real estate. In simple terms, REITs take the money of several investors and invest the total sum in commercial real estate like apartments, malls, hotels, and warehouses. REITs do not develop a property to resell, rather they develop properties to operate them for consistent income. Investors benefit from a steady stream of dividends and appreciation of their shares.
Real Estate Investment Trust allows investors to diversify their portfolio and profit from the real estate market without having to buy, finance, and operate the properties themselves.
Hence the best REITs are known for offering high returns and capital appreciation. This growth or capital appreciation is what brings in significant risks, still depending on the type of REITs.
How does a real estate investment trust work?
In 1960, Congress created REITs to allow various individual investors– not just the wealthy – to buy shares in commercial real estate portfolios.
Investors can invest in a real estate investment trust the same way they would typically invest in any other company. This is by purchasing individual company stock or via mutual funds. The REIT Company then pays steady income to shareholders from the income generated from real estate investments.
These investments can take any form from mortgage to equity or a combination of both. We discuss more of this below.
REITs income-producing real estate or portfolio may include apartment buildings, healthcare facilities, hotels, office buildings, retail centers, warehouses, and so on.
A REIT company may also focus on a particular type of property or multiple types of properties.
Most REITs can be publicly traded and investors can buy and sell them like in stock exchange-traded during trading sessions. As is common with the real estate market, REITs are regarded as very liquid instruments.
When it comes to assets, REITs own over $3.5 trillion in gross assets across the U.S. In addition, stock exchange REITs own about $2.5 trillion in assets.
What qualifies a REIT?
To qualify as a REIT a company must meet the standards set by the Internal Revenue Code (IRC). These standards include;
- A real estate investment trust must have no more than 50% of its shares owned by five or fewer shareholders during the last half of a taxable year. To ensure general compliance most REITs limit the ownership of investors to 10%.
- A REIT must invest at least 75% of its total assets in real estate, U.S treasuries, or cash.
- Real estate investment trusts must also derive at least 75% of its gross income from real estate investments. This includes sources like rent, mortgage payments, and other real estate sources.
- REITs must pay at least 90% of taxable income as shareholder dividends each year. This particular requirement makes REITs offer one of the best interest rates and high dividends on investment. Some REIT companies even pay out 100% of taxable income.
- A REIT must be structured and taxable as a corporation. It must also have a minimum of 100 shareholders after its first year of existence. As a result of this 100-shareholder requirement, many REITs start as real estate partnerships before converting to a REIT at a later time.
- REITs must be managed by a board of directors or trustees.
One of the major reasons a company would want to qualify as a REIT is to be able to pay no corporate tax – this means no taxable income from the company. No matter how much money a real estate investment trust makes, they are never required to pay corporate tax. Taxes are only obtained as dividend taxes at an individual level. This is often a huge benefit for these businesses.
Types of REITs
Earlier we mentioned that REITs can take various forms within the real estate market. These forms are better termed types of REITs.
Equity REIT
Equity REITs are the most common types of REIT. In equity real estate investment trusts, the company owns and manages the property. They operate like a landlord providing upkeep, maintenance, reinvesting, and collecting checks. Equity REITs mostly focus on commercial real estate and the source of income is rental income. Examples of equity REITs include shopping malls, senior housing, and apartment buildings.
Mortgage REITs
Mortgage REITs or mREITs are different from their equity counterpart. Instead of owning the property, the company owns debt securities backed by properties. Mortgage REITs provide loans to real estate owners either directly or indirectly. The income is produced via net interests and mortgage REITs are mostly classified as financial stocks because of this approach.
mREITs generally pay out higher dividends and thus present more risks than equity type.
Hybrid REITs
As you might have guessed, a hybrid real estate investment trust is a combination of mortgage and equity REIT. Such companies have a portfolio that contains both owning and operating real estate for rental income and property mortgages for interest.
There are only a few hybrid REITs in existence.
Is a REIT a good investment?
So far you have gathered basic knowledge on real estate investment trusts including what they are and how they work. REITs pay out in steady dividend income and long-term capital appreciation.
But does knowing all of this make REITs a good investment?
Benefits of investing in REITs
Generally, REITs are considered a good investment for the following reasons –
- Individual investors get to earn profits from income-producing real estate without having to own, run, or manage the real estate properties themselves.
- It allows you to add real estate to your investment portfolio.
- Investors are almost guaranteed short or long-term capital appreciation.
- The various ways of owning REIT shares, using REITs mutual funds, ETFs, and so on further diversify how you can invest. The low correlation of REITs to other asset classes is another advantage in diversifying your total assets.
- Owning a real estate investment trust index fund gives you access to real estate asset classes with low minimums.
- REITs have better performance than other investments even in a slow economy because of the long-term appreciation of properties.
- Since a REIT can be publicly traded on major stock exchanges, it is operated under the same rules as other listed U.S securities for proper regulation.
Does this mean a real estate investment trust is a zero to low-risk investment? Hardly.
Risks associated with REITs
While REITs perform greatly as an investment, they are not without risks and drawbacks. It’s always up to the investor to decide if the risks outweigh the benefit or not.
These risks may include;
Fees.
Upfront fees are often between 9 and 15% for non-traded REITs.
Lack of liquidity.
While real estate is considered a liquid asset, there are times where it’s impossible to get a buyer or seller in the market when you need them. Mostly non-traded REITs can’t be sold for at least 7 years. But some allow investors to retrieve some parts of their investment after a year with a fee.
No share value transparency.
It can be difficult to determine the value per share of non-traded REITs. It doesn’t help that non-traded REITs typically do not provide the value of their shares till after their offering is closed. Because of this, you might be unable to assess the value of your investment for a significant time.
How to invest in REITs
To invest in publicly-traded REITs, REIT mutual funds, and REIT exchange-traded funds you have to buy shares through a broker. For non-traded REITs, you can also purchase shares through a broker or financial advisor participating in non-traded REITs offering.
Another way to invest in a real estate investment trust is by using retirement savings or other investment funds to buy REITs via defined benefit plans and defined contributions.
A defined-benefit is a retirement plan sponsored by your employer. REITs are now being included in such investment plans.
Tips for investing in REITs
Get help from experts
To help you get started on the right path, find a financial adviser or planner to analyze your financial goals and recommend the most suitable REIT investment opportunities.
Do your research
Deciding which REIT to buy can be tougher than you think considering that there are over 200 of them in the U.S. Things to look out for to help with making the right choice include – the company’s track record, management team, method of compensation, and so on.
Look out for the REIT’s expected growth in earnings per share, total returns, and current dividends yields or interest rates.
Make smart moves
Try maintaining a tax-advantaged account for your investment to help you defer on the distributions.
You can avoid trading individual REIT stocks by buying a mutual fund or ETF.
How to avoid REIT fraud
Fraud exists literally everywhere there’s money to be made. Regardless of if you are experienced in REITs or not, it’s important to be cautious.
Avoid buying REITs not registered with the Securities and Exchange Commission (SEC). According to the U.S Securities and Exchange Commission, SEC has advised that “You can verify the registration of both publicly traded and non-traded REITs through the SEC’s EDGAR system. You can also use EDGAR to review a REIT’s annual and quarterly reports as well as any offering prospectus.”
You can also lookup an investment professional such as a broker or advisor for license and registration before going further with them.
Final thoughts
REIT businesses present a convenient way for you to invest in real estate and receive high returns on consistent dividends. All without the hassle of managing and financing properties. They are often seen as a good investment choice but even the best investors advise using REITs for long-term investments rather than short-term returns.
The reason being that several factors such as interest rates affect REITs in the short term.
REIT dividends offer the much desired passive income with stability and diversity of an investment portfolio.
Need to know more before you start? Be sure to reach an investment professional for practical guidance.
