Your Guide to Real Estate Investment Trusts (REITs)

Do you want to invest in stable real estate investments, but you either don’t have the capital to purchase a building outright or don’t have the time to commit to property management? Real estate investment trusts (REITs) are an excellent way for investors to access real estate investments without having to purchase a property outright or worry about the day-to-day management of an asset.

A REIT is a type of investment vehicle that allows individual investors to invest in large-scale, income-generating real estate through a trust that manages property acquisition, management, and divestment for a pool of investors.

REITs trade on the major stock exchanges, just like stocks, and they provide investors with exposure to real estate investments while offering potential advantages such as diversification and liquidity.

Investing in REITs means that you can access various asset classes, and they often allow investors to invest in asset classes that would otherwise be completely unachievable privately. Many REITs are composed of significant assets such as shopping malls, office buildings, and apartment complexes. What makes these asset classes attractive is their stability, as they often have national tenants with long-term lease structures.

REITs collect income in the form of rent, which generates a profit that gets distributed to investors in the form of dividends, just like stocks. By law, REITs must distribute at least 90% of their taxable income to shareholders. Income-focused investors find REITs attractive because they can benefit from regular cash flow without purchasing individual properties themselves.

Benefits of REITs

REITs offer several benefits for investors who want to benefit from real estate as an investment option. Besides having relatively low capital requirements that make them accessible to a wide range of investors, REITs offer:

  • Diversification: REITs provide exposure to real estate, which can be an excellent way to diversify a portfolio primarily made up of stocks and bonds. REITs also have a built-in diversification; investors are not putting their capital into a single property but a group of properties. Therefore, if one property underperforms or becomes vacant, other assets in the REIT continue generating income.
  • High dividends: REITs are required to pay out a significant portion (90%) of their taxable income as dividends, which means that investors don’t need to worry about the entity holding onto capital and can be confident in receiving cash flow.
  • Professional management: REITs are managed by professional real estate companies who engage experienced asset managers, so investors don’t have to worry about the day-to-day management of the properties and can be confident that the property is in good hands.
  • Liquidity: REITs are publicly traded on major stock exchanges, just like traditional stock commodities, so they can be bought and sold easily, unlike privately held real estate investments which are illiquid.

REITs also offer investors the potential for capital appreciation, which is the increase in the value of an asset over time. If real estate prices rise due to market forces or positive economic conditions, REIT share prices will also rise. Therefore, REITs are a good way for real estate investors to access cash flow and benefit from the changing markets without private ownership. However, it also means that the value of their REIT share will drop if market conditions worsen.

What Types of REITs are there?

There are three main types of REITs which are classified based on the type of properties they own and the income they generate:

  1. Equity REITs: The most common type of REIT is an Equity REIT, which owns and operates income-generating properties. They generate income from the rent paid by tenants and distribute a portion of this income to shareholders in the form of dividends.
  2. Mortgage REITs: These REITs do not own properties but rather lend money to real estate owners and developers to finance the purchase or construction of properties. They generate income from the interest on these loans.
  3. Hybrid REITs: These REITs combine elements of both equity REITs and mortgage REITs, owning a mix of income-generating properties and providing financing to real estate owners and developers. They generate income from both rent and interest on loans.

How can you buy a REIT?

REIT Classification

REITs fall under one of three categories and are classified based on how they are traded and who is allowed to invest.

  1. Publicly Traded REITs: These REITs are traded on a public stock exchange, such as the NYSE or NASDAQ, meaning they are easily bought and sold, and their prices are determined by supply and demand in the market. Publicly traded REITs must disclose financial information to the public and are subject to the same regulatory requirements as other publicly traded companies. They are the most liquid form of a REIT.
  2. Public Non-Traded REITs: These REITs are also publicly registered but not traded on a public stock exchange. Instead, they are typically sold directly to investors through a broker-dealer. Public non-traded REITs may be more difficult to sell than publicly-traded REITs, as they do not have the same level of liquidity.
  3. Private REITs: These REITs are not registered with the Securities and Exchange Commission (SEC) and are not traded on a public stock exchange. As a result, they are not required to disclose financial information to the public and are subject to less regulatory oversight. Private REITs are typically only available to accredited investors or sophisticated investors and are often less liquid than publicly traded REITs.

Portfolio Diversification

Many everyday investors target single-family residences or small multifamily properties for their real estate investments because more significant properties are out of reach. REITs are an excellent way for these investors to diversify their real estate portfolios. Many REITs specialize in specific asset classes, such as:

  • Retail REITs: These REITs own shopping centers, malls, and large standalone retail outlets.
  • Residential REITs: These REITs own and manage multifamily properties.
  • Healthcare REITs: These REITs own and manage medical real estate properties such as hospitals, medical centers, and nursing homes.
  • Office REITs: These REITs own large office buildings.

Remember, REITs do not own the businesses, only the real estate assets that are leased to the businesses. However, a real estate investment’s success can largely depend on its tenant’s success, so it’s important to consider the sustainability of tenant business models as well as the REIT’s track record before investing.

When deciding on the type of REIT to invest in, select an asset class that you are comfortable with, then research the holdings and track record of a REIT that specializes in your preferred asset class.

Purchasing a REIT

Real estate investment trusts can be purchased on major stock exchanges, but you can also acquire them in a mutual fund or EFT. They can be bought through a normal brokerage or retirement accounts. Some workplace retirement accounts allow you to buy shares in REITs as well.

It’s essential to do your research before investing in real estate investment trusts. Make sure you understand the risks associated with each different type of REIT and look for a fund that is diversified across multiple real estate asset classes. Additionally, be aware of fees and expenses associated with any real estate investments, and ensure you are comfortable with the level of risk.

If you’re interested in non-traded or private REITs, you’ll need to connect with a broker who will show you various options. Remember, private REITs are limited to accredited and sophisticated investors and can be less liquid than public REITs.

Real estate investment trusts offer investors a way to diversify their real estate portfolio or invest in real estate without purchasing properties directly. It requires minimal work on behalf of the investor, making it attractive for those who want cash flow and appreciation without the hassle of property management.

Before investing in real estate investment trusts, you need to understand how different REITs may fit into your portfolio. Research the holdings of each real estate investment trust before committing to any investments. With a thorough understanding of real estate investment trusts and knowledge of which REITs are best suited for you, real estate investments can help you diversify and build long-term wealth.

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