Traditionally, investing in real estate was something reserved only for the extremely wealthy. But that changed with the introduction of real estate investment trusts (REITs).
A REIT allows you to invest in real estate without having to buy and manage properties yourself. It’s a good way to diversify your portfolio outside of the stock market, though you may still take a hit during an economic downturn.
This article will discuss some of the pros and cons of REITs, and how you can get started with this investment strategy yourself.
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.
Many people like investing in REITs because they provide a steady stream of income. And since most REITs are publicly-traded equity REITs, they are a highly liquid investment, which makes them easy to buy and sell.
According to the Internal Revenue Code (IRC), a company must meet the following requirements to be considered a REIT:
- Return a minimum of 90% of taxable income to shareholders in the form of dividends each year.
- Invest at least 75% in real estate assets or cash.
- Receive at least 75% of gross income from rent, interest on mortgages, or real estate sales.
- Be taxed as a corporation.
- Have a board of directors or trustees.
- Have a minimum of 100 shareholders after its first year of existence.
- Have no more than 50% of its shares held by five individuals or less.
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 of 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.
- Certain types of REITS can be risky: Not all REITs are created equal and in particular, non-traded or private REITs are not as easy to sell.
- Can be expensive: Certain types of REITs require a minimum investment of $25,000 to get started.
- 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 actually several different 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 the national securities exchange and are regulated by the 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 usually 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?
A REIT is listed on public stock exchanges, so individuals can buy them using a traditional brokerage account. You can also purchase shares in a REIT mutual fund or exchange-traded fund (ETF).
If you’re not sure how to get started, you can also work with a broker or financial planner. They can lead you in the right direction and help you find the investment that’s right for you.
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, then REITs could be a good alternative for you.
A REIT is a good way to diversify your portfolio and benefit from steady dividend payments. It tends to be a highly liquid asset, so it’s much easier to buy and sell than traditional real estate.
However, non-traded and private REITs tend to be riskier, less transparent investments. The most important thing you can do is to make sure you know what you’re getting into and to read the fine print before investing in anything.
And if you’re not sure where to start, it can help to consult with a professional. They can help you determine the best investment strategy for you.
Interested in learning about different types of REITs? Check out our full review of Fundrise to learn more.