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 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 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?
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).
REIT ETFs and mutual funds offer investors the opportunity to gain exposure to real estate through a single investment, rather than having to buy and manage individual REITs.
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 suitable 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 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.
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 collecting rent from the tenants of the properties they own. They may also generate income from the sale of properties, although this is less common.
How are REITs different from other real estate investment options?
REITs are different from other real estate investment options since most are publicly traded on stock exchanges, like stocks. This means that individual investors can buy and sell REIT shares easily and quickly, just like any other publicly traded security.
Investing in a publicly traded REIT can be a way for individual investors to gain exposure to real estate without having to directly buy and manage properties themselves.
Are REITs a good investment?
REITs can be a good investment for investors who are looking for a way to diversify their portfolio and earn income from real estate. However, like any investment, REITs come with risks. So, it’s wise to carefully consider the potential risks and rewards before making a decision to invest.
What are the risks of investing in REITs?
REITs are subject to the same risks as any other investment, including market risk, credit risk, and interest rate risk. In addition, REITs are dependent on the performance of the real estate market, which can be affected by factors such as economic conditions and natural disasters.
Can REITs be held in a retirement account?
Yes, REITs can be held in a retirement account, such as a traditional or Roth IRA.
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?
Some REITs may allow investors to purchase shares directly from the company, rather than through a brokerage account. However, this is not common and most REITs are traded on stock exchanges and can be purchased through a brokerage account.
Are REITs suitable for all investors?
REITs may not be suitable for all investors. It is important to carefully consider your financial goals, risk tolerance, and investment horizon before deciding whether REITs are a good fit for your portfolio. Before making any investment decisions, you should consult a financial professional or conduct your own research.