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In the 1950s, most people were just settling down after a difficult decade in the 40s. Mostly, it was about finding a place to raise a family and have a nice quiet life away from all the chaos.
Part of that endeavor was buying a home.
Just buying a home was enough for most people, and the idea of investing in real estate was simply left to the professionals on Wall Street.
However, in 1960, the US government created the Real Estate Investment Trust (REIT) to allow regular people to invest in real estate and benefit from the diversification of the enormous real estate market.
This article will provide you with everything you need to start your REIT research and start investing.
What Is a REIT?
A REIT is a company that either owns or finances multiple properties to generate income for its shareholders.
This is just the one-liner description – they are much more complex than this.
REITs can be anything from companies owning or renting residential properties to owning tenant-based business spaces or cell towers.
As mentioned earlier, Congress created REITs, and they laid out rules for exactly how to qualify as a REIT. These companies must
- Be modeled after a mutual fund
- Be treated as a corporation by the IRS
- Be widely held by shareholders
- Own or finance real estate as the primary source of revenues
- Own its holdings for a long period of time
This may seem vague, but that’s par for the course at the IRS. Regardless, for everyone out there not interested in starting a REIT, just know they are regulated, and we’ll get more specific in the next section on these rules.
So, when you go shopping for REITs to add to your portfolio, you can mostly be sure that you’re invested in real estate.
There are risks involved with any investment, and you need to do some homework, so let’s dig further!
How Do REITs Work?
If REITs weren’t available, most people would be restricted out of real estate because of the huge buy-in requirement (down payments, mortgages, taxes, and maintenance) of even one property.
With REITs, there are several types, from publicly traded to mutual funds of REITs, and the buy-in cost for those is significantly more reasonable.
When you buy shares in REITs or mutual funds of REITs, you receive income as dividends based on the size of your position in the REIT.
Dividends for REITs work a bit differently than typical companies – the government requires them to return 90% of taxable income to shareholders every year.
To get more specific from the last section, they must also
- invest 75% of total assets in real estate or cash
- receive at least 75% of gross income from real estate
- have at least 100 shareholders after the first year of being in business, and
- have no more than 50% or shares owned by five or fewer individuals
REITs can also benefit from paying lower taxes as a result of qualifying for that status.
Most companies might pocket that savings or pass it to executives, but those pesky rules above make sure that any savings get passed to investors one way or another.
There are several types of REIT, which we’ll get into shortly.
Types of REITs
- Mortgage REITs: Remember that while “mortgage” may make you think of regular people taking out mortgages, businesses take out mortgages, too. Mortgage REITs don’t own property but own the debts associated with properties. You may remember the 2008 financial crisis where mortgage-backed securities had a hand in that chaos. Mortgage REITs aren’t quite the same, but they do carry more risk but pay higher dividends to investors willing to accept that risk.
- Equity REITs: Equity REITs own and manage all of the properties in their portfolios. You’ll find that most REITs fall within this category. These companies tend to be more stable because they generate revenues from rent rather than buying and selling properties. While not all equity REITs are publicly traded (i.e., you can buy and sell shares like stocks), the ones that are publicly traded tend to be better investments for reasons of stability, access, and liquidity.
- Hybrid REITs: As you might imagine, the name gives it away because hybrid REITs combine mortgage and equity REITs. In other words, they generate income from rents paid on properties they own as well as from monthly payments on mortgages (debts). These may require a deep dive into the dreaded prospectus before investing so that you have a better understanding of the company’s portfolio.
- Publicly Traded REITs: We briefly touched on this above, but some REITs are publicly traded just like any other company listed in the stock market. From your brokerage account and, in most cases, your retirement account, you can choose from over 200 publicly-traded REITs and REIT exchange-traded funds (ETFs). These companies tend to offer more liquidity, meaning you can buy and sell shares with ease if you want to adjust your portfolio, and the companies themselves are required to offer more transparency due to reporting standards for publicly traded companies.
- Public Non-Traded REITs: While these are registered with the SEC, public non-trade REITs are accessible from brokers specializing in these types of assets. These REITs are generally illiquid, and some companies require you to keep your money invested for months or years before you can pull your funds. However, the lack of market fluctuations may be a benefit to those not worried about accessing funds. Investors should also be cautious about the value of their investments, which may not be fully known when you first invest in these assets.
- Private REITs: As the name implies, these are somewhat elusive since they are not registered with the SEC. The portfolio’s value may not be fully known, and the account minimums tend to be much higher. As such, private REITs are typically left to institutional investors looking for higher yields.
What Are REIT ETFs?
A REIT ETF is exactly like an equity ETF but restricted to those companies registered at REITs.
An ETF is publicly traded like the SPY (SPDR S&P 500 ETF), so it is liquid but subject to more fluctuations as a result.
REIT ETFs are composed of publicly traded REIT securities, including equity, mortgage, and hybrid REITs). As a result, they come at very low expense ratios because of their status as publicly traded.
Because of this, REIT ETFs are excellent choices for investors interested in diversification but who may not have the experience to choose a single REIT to invest in.
What Are REIT Mutual Funds?
REIT Mutual Funds are similar to ETFs in that they are combinations of REITs. The purpose of these is to allow investors to add real estate to their portfolios without needing to choose from specific REITs.
They come with higher expense ratios than ETFs since they are managed funds and are generally created in-house at investment firms by fund managers.
Mutual funds generally don’t experience the fluctuations of ETFs since they are not publicly traded, and the offerings may vary by including anything from only a few REITs to all of the publicly-traded REITs.
In other words, REIT mutual funds offer investors willing to do some research a bit more fine-tuning of their portfolio.
How to Invest in REITs
REITs are generally very easy to invest in unless you’re in the market for private REITs. A publicly traded REIT only requires a simple brokerage account at your friendly neighborhood investment firm.
Once you open an account and deposit your money, you can easily trade into any asset offered by the investment platform.
The largest and most stable firms (think Vanguard or Fidelity) will offer investors easy access to individual REITs, REIT ETFs, and REIT mutual funds with a few clicks of your mouse.
Alternatively, you can look to newer companies like Fundrise or RealtyMogul to invest in public non-traded REITs.
We’ll get more into those shortly.
Pros and Cons of Real Estate Investment Trusts (REITs)
- Exposure to Real Estate: Before REITs, real estate was extremely difficult to invest in unless you had plenty of cash on hand. Now, investors can invest in REITs and reap the benefits.
- Consistent Dividends: Real estate makes money by providing a cash flow stream in the form of dividends. Dividends are an excellent way to ensure investors can profit from the magic of compound interest, and REITs offer exposure to this with companies that mostly provide a stable return.
- Low Volatility: Even REITs that are publicly traded see less volatility than regular stocks unless some extreme news is released about a particular company. While every investment comes with some risk, REITs can help protect investors from huge fluctuations.
- Higher Returns: Dividend payouts on some REITs and REIT funds are generally higher than most companies. This is because almost all of the returns must be given back to the investor by law
- Diversification: Simply investing in a stable cash-flow-generating investment like REITs can give your portfolio that much-needed diversification so that you can gain exposure to as many markets moves as possible.
- Transparency: Publicly traded REITs must release reports regularly to shareholders as required by the SEC. This gives investors a good look at what the company is investing in and how those investments are estimated to perform in the future.
- Low Growth: Unlike big growth stocks that have created millionaires and billionaires, REITs will generally not take anyone up to the next tax bracket. House prices, residential and business rents, and other REIT investments must rise slowly by design, so they are not going to see huge profits.
- Additional Taxes: Unless you’re holding REITs in your tax-advantaged retirement account (traditional IRA or 401k), then dividend income from REITs is taxed like normal income.
- Some REITs Are Expensive: For those interested in potentially higher gains, non-traded REITs may give that to investors – at a much higher buy-in. However, some funds may require $25,000 or more and come with management fees.
- Watch Out for Hidden Fees: When shopping for any investment vehicle, you’ll find some funds that come with additional fees. These are supposed to be clearly stated, but always read the fine print before investing.
5 Tips for Investing in REITs
#1. Make Sure You Research Various REITs
As mentioned before, there are REITs for cell towers, REITs for shopping centers, REITs for digital storage warehouses, and more!
If you find a niche that you understand, there’s probably a REIT that will keep you engaged. In any case, look around at what’s out there and make sure you’re investing in a quality company.
#2. Do Not Over Allocate
No matter how much research you’ve done or how good the company looks, you should never invest your entire portfolio into one REIT.
You may see huge returns for the past five years but remember that doesn’t guarantee that will continue forever.
Spread out your risk so that one bad day won’t wipe out your position.
#3. Monitor Your Position
If you invest in several REITs, be prepared to read. In addition, you’ll want to monitor the companies you invest in to see if there are any red flags on the horizon.
Barring any restrictions to withdrawals, you may need to have the flexibility to move money around to different assets depending on the market.
#4. Recognize the Risks Involved
Risks could come from anywhere. While REITs fluctuate differently than stocks and bonds, there are always risks involved.
There is interest rate risk – if the Fed raises interest rates, REIT companies will find it harder to put capital into new investments, limiting growth.
There is market risk – if 2008 taught us anything, it’s that no market is immune to a potential catastrophe.
Regulatory risk changes in regulation can have a huge effect on REIT companies since most are so heavily regulated and monitored.
This is just a snapshot of some of the biggest risks but understanding them is crucial to understanding how to allocate your money.
#5. Take Note of REIT Fees
You should fully understand exactly what the REIT, REIT ETF, or REIT mutual fund will charge in fees. For example, if the return averages about 5% but the fund takes 3%, your return of 2% doesn’t even cover inflation. Of course, this example is outrageous, but it helps illustrate the point.
Consider Real Estate Crowdfunding Platforms
The Jumpstart Our Business Startups (JOBS) Act of 2012 loosened regulations on small businesses instituted by the SEC.
While it had many effects, the one we care about is opening the door to crowd-funded REIT companies. We’ll talk through several here since it might be a good fit for some investors.
DiversyFund offers the lowest fees and account minimums in the industry. Even as the newest platform to enter the market, it has attracted a legion of die hard fans.
If you are new to REIT investing, then DiversyFund is the platform we recommend due to its ease-of-use, price, and transaction deal flow.
>> Learn More:DiversyFund Review
Fundrise started with a simple goal – to allow any individual to invest in real estate with as little as $100.
Not only that, but investors could also choose which property they could invest in. This led to people investing in local storefronts or developments.
While this practice has since been suspended, the company still offers large portfolios with a minimum $1,000 investment and lower fees than other investment firms.
>> Learn More: Fundrise Review
Crowdstreet focuses on providing a marketplace of yet-to-close real estate investment opportunities.
These deals are mostly commercial real estate, but the minimum investments can be quite high, some as high as $150,000 minimum.
Crowstreet is for more savvy real estate investors looking to park money in well-researched opportunities.
RealtyMogul offers a slicker website and several investment options: REITs, individual properties, and even 1031 exchanges.
1031 refers to profits from sales of real estate and would need a lot more explanation. It’s one of those “if you don’t know about it, don’t worry” things.
The minimum investment for the REITs starts at $5,000, and individual property investment minimums start at $25,000.
>> Learn More:RealtyMogul Review
Real Estate Investment Trusts FAQs
Is a REIT a Good Investment?
Yes! As long as you do some research and know what you’re getting into, REITs are excellent assets to have in your portfolio.
Can You Lose Money in a REIT?
Every investment comes with risk, and REITs are no different.
The publicly traded companies could potentially declare bankruptcy, which means shareholders lose their investment.
However, a little research can help you avoid riskier assets.
>> Dive Deeper: How to Research Stocks
Why Are REITs Sometimes a Bad Investment?
Of course! REITs can be bad investments in high-or rising-interest-rate markets since returns and reinvestments are far more limited.
How Are REIT Dividends Taxed?
Dividends from REITs are taxed as regular income with a regular brokerage account.
Bottom Line: What Is a REIT?
REITs are an excellent opportunity for regular investors to diversify their portfolios with a relatively stable, income-generating asset.
They are easily accessed from a regular brokerage or retirement account platform. In addition, there are several levels for each type of investor out there, so you don’t have to be a real estate expert to have an acceptable level of exposure.
While every investment carries risks, the advent of the REITs brought the real estate market closer to the average investor.