Investing in real estate has always been a popular choice for individuals looking to grow their wealth. However, not everyone has the means or the expertise to become a landlord or purchase commercial properties. That's where Real Estate Investment Trusts (REITs) come in. In this article, we will explore the basics of REITs, the different types available, and the advantages and disadvantages of investing in them.
What is a REIT?
A Real Estate Investment Trust is a company that owns and operates income-producing real estate. They own various types of commercial properties like office buildings, shopping centers, hospitals, and even data centers. REITs function as dividend-paying stocks, allowing average individuals to invest in large-scale, income-producing real estate without the hassle of property management. It's like investing in commercial real estate from the sidelines.
Types of REITs
There are different types of REITs, each with its own unique characteristics:
Equity REIT
In this type of REIT, a group of investors actually owns the physical property. This means that investors can directly benefit from the appreciation of real estate values.
Mortgage REIT
Investing in mortgage REITs means investing in the mortgages of commercial properties rather than the properties themselves. These REITs generate income from the interest generated from lending money.
Exchange Traded Funds REIT
ETFs are stocks that invest in other REIT stocks. They offer a diversified basket of REIT holdings and are traded on the stock exchanges.
REIT Qualification Rules
For a company to qualify as a REIT, it must meet certain criteria set by the IRS. This includes having a long-term investment horizon, investing at least 75% of its total assets in real estate, and deriving at least 75% of gross income from rents, interest on mortgages, or real estate sales. Additionally, REITs must pay out at least 90% of their taxable income as dividends to shareholders.
Most Common REITs
Now let's take a look at some of the most common types of REITs:
Retail REIT
Retail REITs invest in shopping centers and malls, relying on rents from their tenants. While these REITs have faced challenges in recent years, it's important to carefully research and consider the success of the retailers they are associated with.
Residential REIT
Residential REITs focus on class-A apartment buildings and manufactured housing. These REITs are dependent on factors like demographics, migration patterns, and job creation.
Office REIT
Office REITs invest in office buildings and earn income from tenant rents. Considering local economic factors like unemployment rates and vacancy rates is crucial when evaluating office REITs.
Mortgage REIT
Mortgage REITs are popular and primarily generate income from interest on mortgages. They invest in mortgage-backed securities.
Healthcare REIT
Healthcare REITs own properties such as hospitals, medical centers, nursing facilities, and retirement homes. Success for these REITs depends on factors like occupancy fees, Medicare and Medicaid reimbursements, and private pay.
How Can I Invest in REITs?
Investing in REITs is as simple as purchasing stocks through a major broker. Websites like REIT.com, Dividend.com, and Marketrealist.com provide information on the performance and dividends paid by various REITs.
Keys to Assessing Any REIT
- Look for a track record of producing high dividend yields and long-term capital appreciation growth.
- Consider liquidity and whether the REIT is traded on the stock exchange for flexibility.
- Strong management is crucial, so opt for companies with experienced management teams.
- Quality matters, so invest in REITs with great properties and reliable tenants.
- If you prefer a hands-off approach, consider buying a mutual fund or an ETF that invests in REITs.
The Benefits and Advantages of Investing in a REIT
Investing in REITs offers several benefits:
- REITs are required to pay out at least 90% of their income as dividends, providing potentially higher returns compared to the stock market.
- REIT income is secured by long leases, ensuring a stable income stream over time.
- REITs are liquid and can be easily bought and sold on major stock exchanges.
- REITs are professionally managed by experienced real estate professionals.
- REIT operations are transparent, as they are required to make regular disclosures to the SEC.
Disadvantages of Investing in a REIT
While there are advantages, it's important to be aware of the potential downsides:
- Lack of diversification: Investing in a single or limited number of REITs can lead to problems if a particular sector underperforms.
- Slower growth: REITs are required to distribute a significant portion of their income as dividends, limiting their ability to reinvest and potentially impacting growth.
- Tax considerations: REIT dividends are taxed as personal income, which may disadvantage investors in higher tax brackets.
- Limited tax benefits: Unlike owning physical commercial real estate, REIT investors are unable to offset losses on their tax returns.
Is it Better to Do My Own Investing?
Investing in REITs offers convenience and hassle-free investing. The responsibility of property management lies with the REIT, and liquidity provides the flexibility to exit investments if desired. However, if you choose to invest directly in commercial real estate, you have more control over your investments and can enjoy benefits like greater cash flow, higher returns, and the ability to leverage your investment or participate in syndication.
Conclusion
Real Estate Investment Trusts present a unique opportunity for individuals to invest in income-producing real estate without the challenges of property ownership. Understanding the different types of REITs, assessing their performance, and considering the benefits and drawbacks will help you make an informed decision about whether to invest in REITs or pursue your own real estate investments.