Explaining Real Estate Investment Trusts (REITs)
Explaining Real Estate Investment Trusts (REITs)
What is a Real Estate Investment Trust (REIT)? REITs are companies that own or finance and operate real-estate ventures designed to produce income. They can be any type of real estate property - from warehouses, to medical facilities and office buildings, to apartments, to commercial real estate, and more. They can even be hotels or cell towers. In recent years, REITs have steadily become more popular with investors who are looking to grow their portfolio outside of traditional stocks or mutual funds.
Still wondering what is a REIT? Read on to learn the ins and outs of this unique investment opportunity. We’ll define REITs, discuss the types that are out there and explore the pros and cons you should know about.
How Do REITs Work?
REITs work in a manner similar to how making money in the stock market works. You earn money through dividends paid from the company’s profits, and you can always sell your shares once their value increases. In short, investing in REITs can mean being able to buy equity in large scale real estate opportunities you may not otherwise have been able to afford.
Are REITs Liquid
Yes, REITs are liquid (most of them, at least). Because they’re publicly traded (think: stocks), they’re much more liquid than some other types of real estate investments. Liquidy is an important factor to consider any time you’re concerned about the risk tolerance. If you are at all worried about needing to quickly and easily recoup your money, you should be looking into more liquid investment opportunities.
Types of REITs
There are 3 broad types of REITs, which are categorized based on their investment holdings. Each REIT type has specific characteristics and risk levels you should know about and understand before deciding which (or if) to invest in.
You can think of Equity REITs like you think of a landlord. The owner of the property collects the rent, handles all the upkeep and maintenance and deals with any of the other management tasks that come to mind when we think about owning property.
Mortgage REITs (also known as mREITs) are slightly different. Instead of owning the actual property, the ownership is in the form of debt securities that are backed by the property. mREITs are typically considered more risky than the other REITS, but with risk in investing generally comes reward. And as you may suspect, mREITs often reward investors with higher dividends.
A Hybrid REIT, as the name suggests, combines aspects of both Equity REITs and mREITs. They own and operate both commercial and real estate properties inside their portfolio. It’s important to thoroughly read and understand any REIT prospectus before you invest in a Hybrid REIT so you have a firm grasp of its focus.
REITs by Trading Status
In addition to the different types of REITs available, there is also differentiation based on trading status. How REITs are traded may be a deciding factor for you when determining which REIT you go with.
Traded on an exchange, just like stocks or Exchange-Traded Funds (EFTs), publicly Traded REITs can be purchased with a traditional brokerage account. Advantages include more liquidity and transparency and better governance standards.
Public Non-Traded REITs are not available on an exchange, although they are registered with the U.S. Securities and Exchange Commission (SEC). You can purchase them from a broker who actively participates in this type of REIT. Drawbacks to Public Non-Traded REITs are a lack of liquidity and they’re harder to value.
Because they’re unlisted (hence, the “private”) Private REITs are also hard to value and trade. They’re generally exempt from SEC regulation and registration, and they typically don’t have as many disclosure requirements. All of this makes them much more difficult to evaluate in terms of how they perform. As a result, Private REITs are riskier and less attractive to many investors.
REITs Average Return
While the actual rate of return will vary based on numerous factors, in 2019 the following returns were seen from Equity and mREITs:
- Equity REITs - 28.7%
- Mortgage REITs - 21.3%
Pros & Cons of REITs
So, are REITs a good investment? Just like with any investment opportunity, there are pros and cons to REITs, and understanding them can help you make wise decisions that reflect your individual risk tolerance.
- High Returns - Offering higher returns than equity indexes, REITs can be a great investment for anyone looking to diversify their portfolio.
- Consistent Dividends - REITs consistently offer higher-than-average dividend yields. For investors looking for a steady income stream, REITs may be the opportunity they’ve been searching for.
- Liquidity - Easy to sell and buy, Publicly Traded REITs can be a much more attractive option than actually buying, selling and managing physical investment properties.
- Diversification - Real estate can be a lucrative addition to your portfolio. And with REITs offering higher dividends and steady cash flow on top of diversifying, they can be a real win.
- Taxes - REITs themselves don’t pay taxes, but there can be tax consequences on dividends investors receive. This is why a carefully thought-out investment strategy is needed. Using dividends from REITs to fund IRAs can be an ideal solution.
- Big Debt - REITs inherently carry a lot of debt. That said, long-term contracts that result in consistent and regular cash flow (like a lease) often ease investors’ fears. That said, this is still something to be aware of.
- Low Growth – As a result of consistently paying dividends, REITs need to constantly raise cash in order to grow. Recessions and financial crises can result in wary investors who may not be ready or willing to buy into new stock shares and bonds.
- Potential for High Fees - REITs can have higher transaction and management fees than other investment opportunities.
How to Invest in REITs
You can invest in a REIT through mutual funds, Exchange-Traded Funds (ETF) or even crowdfunding platforms. You can go through an investment advisor, financial planner or broker to invest in Publicly-Traded REITs. And for those investors who don’t want to trade individual REIT stocks, there’s also the option to invest in Non-Traded REITs - you'll just need to find a financial advisor or broker who deals with this type of REIT.
If you’re considering REITs, it’s important that you do your due diligence in a few ways, including:
- Verifying that the REIT is registered on the SEC’s EDGAR system (to eliminate potential fraud). Note, you’ll want to do this for publicly traded as well as non-traded REITs
- Review the prospectus of the REIT you’re interested in - this will ensure you understand fees and any risk
- Look for quarterly and annual reports and review disclosure filings
Take Advantage of REITs with Connect Invest
REIT investing can be a sound option if you’re looking to include real estate in your portfolio but don’t want to deal with the hassle of actual property management. There are a number of different types and several ways to take advantage of the lucrative financial opportunity some REITs offer. Whatever you choose, be sure to do your research beforehand or consult with your financial advisor.
Looking for help? Reach out to Connect Invest today to learn more about how we can help you start your real estate investment journey.