What Is a REIT?

Do you want to invest in real estate but lack the time, expertise, or resources to purchase and manage properties? If so, you might consider real estate investment trusts (REITs). These investments let you buy into a professionally managed real estate portfolio created by pooling investors’ money.

REITs are popular among investors seeking steady income because they pay relatively high ongoing dividends. However, dividends are not guaranteed, and a REIT can reduce its dividend payments.

What Is a REIT?

A REIT is a company that owns, operates, or finances real estate, such as apartment buildings, offices, shopping malls, and data centers. Like stocks, REIT shares often trade on exchanges. When you purchase a REIT share, you become a partial owner of the underlying properties.

How Does a REIT Work?

A REIT raises money from investors to build and manage a real estate investment portfolio. For instance, the REIT might purchase properties to lease to tenants or invest in assets such as mortgages. The REIT collects tenants’ rent or receives mortgage payments and distributes earnings to shareholders.

What Are the Qualifications for a REIT?

A company must do the following to qualify as a REIT:

• Invest at least 75% of assets in real estate.

• Pay out at least 90% of taxable income annually to shareholders as dividends.

REITs receive special tax treatment that may allow them to pay little or no corporate income tax. However, REIT investors typically owe taxes on dividends and realized gains.

What Are the Types of REITs?

 The following are categories of REITs:

• Equity: Equity REITs purchase and operate properties, leasing them to tenants and collecting the rent. These companies can specialize in niches of the real estate market, such as warehouses, data centers, and infrastructure.

• Mortgage: Mortgage REITs use investor funds to finance mortgages, collect mortgage payments, and earn interest. Some companies also purchase mortgage-backed securities and receive regular payments from principal and interest payments.

• Hybrid: Hybrid REITs invest in real estate properties and mortgages.

REITs can also be classified by market:

• Publicly traded: Publicly traded REITs are regulated by the Securities and Exchange Commission (SEC) and listed on major stock exchanges like the New York Stock Exchange (NYSE) and NASDAQ. Looking up company information and buying and selling shares typically is easy.

• Public non-traded: Public non-traded REITs are regulated by the SEC and typically purchased through certain brokers. Non-traded REITs can be more difficult to sell.

• Private: Private REITs are not regulated by the SEC and do not trade on major exchanges. Generally, high-net-worth investors and institutions can invest in private REITs.

Advantages of Publicly Traded REITs

Investing in publicly traded REITs offers the following advantages:

• Low initial investment: Individuals can invest in real estate by purchasing one REIT share. They could start with $1 if they invest with a broker that offers fractional shares.

• Access to cash: Investors can purchase and sell REIT shares whenever markets are open, turning their investment value into cash.

• Potential for ongoing income: Because REITs are required to pay out 90% of their taxable income, they are popular among individuals seeking investment income.

• Diversification: REITs have different characteristics and attributes from traditional stocks and bonds. They might perform better or worse than other investments at different times. Investing in different assets and asset classes supports diversification.

Disadvantages of Publicly Traded REITs

Publicly traded REITs come with disadvantages:

• Research: Investors should thoroughly understand a REIT before investing in it.

• Tax rate on dividends: REIT investors generally owe tax on the dividends they receive, which are typically taxed at higher ordinary income tax rates. Holding REITs in a tax-advantaged account might allow for tax deferment.

• Potential market volatility: Because REITs trade on exchanges, they are subject to market fluctuations.

• Unique risks: REIT issuers do not guarantee a secondary market for their shares. Share redemptions might be lower or higher than the purchase price. Changes in real estate values and economic downturns can negatively impact companies.

How to invest in REITs

Investors can purchase publicly traded REITs like they would stocks, using a company’s ticker symbol. Or, investors can purchase one or more mutual funds or exchange-traded funds that hold REITs.

Mutual funds and ETFs are professionally managed portfolios that combine investors’ funds and invest them in securities. The funds offer investment in a diversified, professionally managed portfolio of REITs without the need to research each REIT. 

Considerations for Purchasing REITs

Consider the following to help decide whether to include REITs in your portfolio:

Your Investing Goal

Determine your investing goal, such as retirement or a child’s college education. Then, research appropriate investment mixes to decide whether REITs should be included. Consider talking with a licensed financial professional for additional guidance.

Diversification 

If you own a home or a broadly diversified portfolio, or you invest in a broadly diversified fund such as a target-date fund, your net worth might be significantly exposed to real estate. If you do not own a home or REITs, adding REIT shares to your portfolio provides exposure to real estate and potential diversification.

Risk Tolerance

Although REITs can generate relatively high income, they are not guaranteed and can lose money.

Need for Liquidity

Publicly traded REITs can be quickly sold and converted into cash. However, the sales price is subject to market fluctuations and not guaranteed.

*This information is for educational purposes only.

Let me know in the comments which personal finance topic I should write about next!