REITs, “real estate investment trusts,” are a great way to make money. They give investors access to professionally managed portfolios of different real estate assets. They are easy to buy and could provide higher returns than other investments. Learn how to invest in REITs in this blog.
Investors should research REITs and choose the ones that best meet their investment goals to make the most money. Also, investors should spread out their holdings and keep an eye on the market to ensure they put their money in the right real estate investment trusts (REITs).
Contents
How to Invest in REITs (Real Estate Investment Trusts)
REIT shares can be bought and sold by investors the same way they can buy and sell shares of any other publicly traded investment. REITs are set up to lower taxes and are often traded on the major stock markets.
Shares of REITs can help investors in many ways. Real estate investment trusts (REITs) are a great way to diversify your portfolio of investments. When you invest in a real estate investment trust (REIT), your risk is spread across many real estate assets. This helps protect you from the underperformance of any one asset class.
Also, REIT owners can get money from the REIT in the form of dividends, which can be a great source of steady income for them.
Lastly, real estate investment trusts (REITs) are good from a tax point of view because their dividends are often taxed at lower rates than dividends from other assets.
What is a REIT?
Real Estate Investment Trust is what REIT stands for. It is becoming more popular among investors who want to add something to their portfolios besides publicly traded company stocks or mutual funds.
REITs own income-generating real estates, like apartments, warehouses, self-storage facilities, malls, and hotels. Often, they also run these properties. Their appeal is easy to understand: the most reliable REITs have a history of paying large dividends that keep growing. Still, this growth potential comes with different risks for each type of REIT.
Real Estate Investment Trusts: How do REITs work?
In 1960, Congress made real estate investment trusts so that individual investors could own shares in large real estate companies, just like they could own shares in other businesses. This change made it easier for investors to buy and sell different kinds of real estate. REITs have to meet certain rules set by the IRS, including that they:
- Return a minimum of 90% of taxable income in shareholder dividends each year. This is a big draw for investor interest in REITs.
- Invest at least 75% of total assets in real estate or cash.
- Receive at least 75% of their gross income from real estates, such as property rents, interest on mortgages financing the real property, or real estate sales.
- Have a minimum of 100 shareholders after the first year of existence.
- Have no more than 50% of shares held by five or fewer individuals during the last half of the taxable year.
By following these rules, REITs don’t have to pay taxes at the corporate level. This lets them finance real estate more cheaply and make more money for investors than companies that aren’t REITs. So, REITs can grow over time and pay out bigger and bigger dividends.
Real Estate Investment Trusts: Types of REITs
Based on the types of investments they hold, REITs can be put into three main groups: equity, mortgage, and hybrid. Each investment model can be further broken down into three types based on how it can be acquired: publicly-traded REITs, publicly non-traded REITs, and private REITs. Every kind of REIT has risks and benefits, so it’s important to know what’s going on before buying.
Real Estate Investment Trusts: REIT types by investment holdings
Equity REITs:
Equity REITs work like landlords and take care of all the management tasks that come with owning a property. They own the property, get rent checks, take care of maintenance, and put the money back into the property.
Mortgage REITs:
Mortgage REITs, also called mREITs, differ from equity REITs because they don’t own the property. Instead, they own securities that are loans backed by the property.
For example, if a family buys a house with a mortgage, this type of REIT might buy the mortgage from the original lender, collect the monthly payments, and use the interest income to make money.
Most of the time, mortgage REITs are much riskier than equity REITs but tend to pay higher dividends.
Hybrid REITs:
Hybrid REITs include both equity REITs and mortgage REITs. These companies own and run real estate properties and also have mortgages on commercial properties in their portfolios. Make sure to read the REIT prospectus so you can figure out what its main goal is.
Real Estate Investment Trusts: REIT types by trading status
Publicly traded REITs:
Like stocks and ETFs, publicly traded REITs are bought and sold on an exchange, and you can use a regular brokerage account to buy them. The National Association of Real Estate Investment Trusts, or Nareit, says that more than 200 REITs can be bought and sold on the stock market.
Publicly traded REITs
Most REITs traded on the stock market have better governance standards and are more open. They also have the most liquid stock, which means that investors can buy and sell it easily and much faster than, say, buying and selling a retail property. Because of these benefits, many investors only buy and sell REITs traded on public markets.
Public non-traded REITs:
The SEC has registered these REITs, but you can’t buy or sell them on an exchange. Instead, they can be purchased from a broker who sells public non-traded offerings, like online real estate brokerFundrise.com.
The Financial Industry Regulatory Authority says that because these REITs aren’t traded on a public market, they are often hard to sell for eight years or more.
It can also be hard to figure out how much a non-traded REIT is worth. The SEC warns that these REITs often give investors an estimate of their value 18 months after the end of their offering, which could be years after you’ve invested.
DiversyFund.comandRealtyMogul.comare two online trading platforms where investors can buy shares in public REITs that are not traded on the stock market.
Private REITs:
Private REITs are not listed, which makes them hard to value and trade. They also don’t usually have to register with the SEC, making it even harder to value and trade. So, private REITs have less information to share, which could make it harder to judge how well they are doing. Because of these restrictions, many investors are less interested in these REITs, which come with more risks.
Publicly non-traded REITs and private REITs
Publicly non-traded REITs and private REITs can also have much higher account minimums—$25,000 or more—and higher fees than publicly traded REITs. Because of this, private REITs and many non-traded REITs are only available to accredited investors.
Accredited investors have been approved by the SEC to invest in complex securities. These investors have a net worth of at least $1 million (not including the value of their main home) or have made at least $200,000 a year if they are single or $300,000 a year if they have been married for the last two years.
Real Estate Investment Trusts: REITs’ average return (ROI)
In the United States, Real Estate Investment Trusts (REITS) have given an average return of 8–10% over the past ten years. This return is much higher than the average return of the S&P 500, which is about 5-6%. REITs are a good choice for investors who want returns that are higher than average.
REITs are usually diversified investment vehicles that spread risk across multiple asset classes, such as residential, commercial, and industrial real estate. This spreads out the risk of investing in a single type of asset and makes the portfolio more diverse. Also, REITs are usually easy to sell, which makes them a good choice for investors who want returns quickly.
Pros of investing in REIT stocks
There are benefits to investing in REITs, especially those that are traded on public markets:
- Steady dividends: REITs must pay out 90% of their annual income as dividends to their shareholders, so they always have some of the highest dividend yields on the stock market. Because of this, investors who want a steady income stream like to buy them. The most reliable REITs have a long history of paying dividends that keep increasing over time.
- High returns: As mentioned above, REITs can have higher returns than equity indexes. This is another reason they are a good way to diversify a portfolio.
- Liquidity: It’s much easier to buy and sell publicly traded REITs than to buy, manage, and sell commercial properties.
- Lower volatility: REITs tend to be less volatile than regular stocks because they pay out bigger dividends. REITs can protect you from the ups and downs of other asset classes that can make you feel sick. But no investment is safe from fluctuations.
Cons of Investing in REIT Stocks
- Illiquid (especially non-traded and private REITs): It’s easier to buy and sell publicly traded REITs than actual properties, but, as mentioned above, things can be different with non-traded and private REITs. To make money on these REITs, you must hold on to them for years.
- Heavy debt: Because of how they are set up legally, REITs also have a lot of debt. They are usually among the companies with the most debt. However, investors have gotten used to this situation because REITs generally have long-term contracts that generate regular cash flow, such as leases. This ensures that money will keep coming in, letting them pay their debts and pay dividends.
- Low growth and capital appreciation: Since REITs pay out so much of their profits as dividends, they need to sell new stock and bonds to get more money so they can grow. Investors are only sometimes willing to buy them, like during a recession or financial crisis. So REITs are only occasionally able to buy property when they want to. The company can keep growing when investors are willing to buy REIT stocks and bonds again.
- Tax burden: Even though REITs don’t pay taxes, their investors still have to pay taxes on any dividends they get unless they have their REIT investments in an account that helps them avoid taxes.
- Non-traded REITs can be expensive: A first investment in a non-traded REIT may cost $25,000 or more, and it may only be available to investors who have met certain requirements. REITs that aren’t traded on the stock market may also have higher fees than REITs that are.
How to Start Investing in REITs
To get started, you must open a brokerage account, which takes only a few minutes. Then you’ll be able to buy and sell publicly traded REITs like any other stock. Because REITs pay such big dividends, it can be smart to keep them in a tax-advantaged account like an IRA so you can put off paying taxes on the distributions.
If you don’t want to trade individual REIT stocks, it can make a lot of sense to buy an exchange-traded fund (ETF) or mutual fund that invests in various REITs. You immediately have more options and less risk. There are a lot of brokerages that sell these funds, and investing in them is easier than researching individual REITs.
FAQ: How to Invest in Real Estate Investment Trusts (REITs)
How do I invest in a REIT?
People can buy shares in a REIT listed on major stock exchanges just like any other public stock. Shares in a REIT mutual fund or exchange-traded fund can also be bought by investors (ETF).
About 150 million Americans live in homes that have invested in real estate through REITs. Many do so through mutual funds and ETFs in their 401(k), IRA, Thrift Savings Plan (TSP), and pension plans.
Nearly all target date funds, common in 401(k) plans, have REIT allocations, and most pension plans, including those for teachers, firefighters, nurses, state government employees, and others, get real estate exposure through REITs.
A broker, investment advisor, or financial planner can help investors figure out their financial goals and suggest REIT investments that will help them reach those goals. A 2020 Chatham Partners study found that 83% of financial advisors tell their clients to buy REITs.
Investors can also put their money into public REITs not listed on the stock market and private REITs.
What is an appropriate allocation to REITs?
The answer will depend on each investor’s goals, risk tolerance, and time horizon, but here are some key points that can help:
Several studies have shown that the best proportion of REITs in a portfolio may be between 5 and 15%. David F. Swensen, PhD, the well-known CIO of the Yale endowment and author of Unconventional Success: A Fundamental Approach to Personal Investment, says that most investors should put 15% of their money into REITs.
Chatham Partners’ research shows that advisors recommend allocating between 4% and 12% of a client’s portfolio to REITs, no matter the client’s age, from early career to retirement.
How does age affect the optimal REIT allocation?
This Wilshire Funds Management Glide Path Model shows that the best allocation for some investors could start at 15% or more for an investor with a 45-year investment horizon, then gradually go down to 7% or more at retirement and 6% or more after 10 years of retirement.
The market sets the price of REIT shares throughout the day, just like it does for all publicly traded stocks. Analysts usually look at the following things to decide if REIT shares are a good investment:
- anticipated growth in earnings per share;
- anticipated total return from the stock, estimated from the expected price change and the prevailing dividend yield;
- current dividend yields relative to other yield-oriented investments (e.g., bonds, utility stocks, and other high-income investments);
- Dividend payout ratios as a percent of REIT FFO (see below for a discussion of FFO and AFFO);
- Management quality and corporate structure; and
- Underlying real estate asset values and/or mortgages and other assets.
REITs must abide by IRS regulations, such as: distributing 90% of income as dividends, investing majority of assets in real estate/cash, deriving most revenue from real estate-related activities, having ≥100 shareholders in year one, and not having >50% of shares held by ≤5 people in the last half of the tax year. These requirements are attractive to investors.
10 Investment Quotes on Real estate investment trusts (REITs)
Q1. Real estate investment trusts (REITs) give investors access to a wide range of investments that are easy to sell and give steady returns and a good yield.
Q2. You can get into the real estate market through REITs, which is a faster way to do so than buying the underlying asset.
Q3. REITs allow investors to buy a real estate portfolio without having to pay for the whole thing themselves.
Q4. REITs are becoming increasingly popular as a way to make money and diversify portfolios.
Q5. REITs are a good investment for many people because they offer a unique mix of diversification, income, and capital appreciation.
Q6. REITs allow investors to get both the appreciation of real estate and the income from the properties that make up the REIT.
Q7. REITs are a great way to invest in real estate without worrying about managing properties or dealing with tenants.
Q8. REITs allow people to invest in real estate without taking on the big risks that come with owning it directly.
Q9. REITs offer an attractive yield and give investors access to the potential for real estate to go up in value.
Q10. REITs give investors a way to invest in low-risk real estate and returns that can be higher than those of other types of investments.
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