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What Is A REIT (Real Estate Investment Trust)?
Real estate is becoming an increasingly popular investment choice for many people. There are many ways that you can invest in the real estate market including residential and commercial real estate investing.
If you're an investor or are interested in getting into real estate investing, you've probably heard the term REIT (Real Estate Investment Trust) before.
But what exactly is a REIT and how does it work? Let's take a deep dive.
Key Points
- A Real Estate Investment Trust (REIT) is a company that owns, operates or finances income producing real estate
- REITs work by pooling capital from many individual investors and then using those funds to finance different real estate projects
- Some common types of properties that REITs own include office buildings, apartment complexes, hotels, medical facilities, data centers, cell towers and warehouses
- Broadly, REITs can be classified based on investment holdings and trading status
- Some advantages of investing in REITs include the fact that they can help investors diversify their investment portfolio and they are also liquid
- Some disadvantages include the fact that taxes are charged on dividends and there is potential high fees and risks
- To start investing in a REIT, you just need to buy individual stocks from a specific company or through a mutual fund or exchange traded fund (ETF)
Disclaimer
The contents of this article are for educational purposes only. They are not intended to be a source of professional financial advice. You will find experts on financial planning, financial management, and real estate here. More on disclaimers here.
REIT definition
A Real Estate Investment Trust (REIT) is a company that owns, operates or finances income producing real estate. REITs are designed to give investors a way to invest in real estate without having to purchase and manage properties themselves.
Similar to mutual funds, they operate by pooling money from individual investors to invest in a diversified portfolio of assets.
How do REITs work?
REITs get their pool of capital from many individual investors and then use those funds to finance different real estate projects. The good thing about investing in REITs is that anyone can invest in them as there are no strict limitations as to who can become an investor.
To begin investing in a REIT, you simply buy individual stocks from a specific company or through a mutual fund or exchange traded fund (ETF). In 2022, it was estimated that about 145 million Americans own REIT stocks.
Typically, what assets do REITs own?
According to data from Nareit, U.S. REITs own approximately $4.5 trillion of gross real estate with public REITs owning $3 trillion in assets. U.S. listed REITs have an equity market capitalization of more than $1.3 trillion and in 2021, REITs paid an estimated $92.3 billion in dividends to shareholders.
Some common types of properties that REITs own include:
- Offices buildings
- Apartment complexes
- Hotels
- Medical facilities
- Data centers
- Cell towers
- Warehouses
Are there different types of REITs?
Yes there are. Here are six different types that you should know about.
By Investment Holdings
Equity REITs
These REITs own and manage the real estate that generates income. Revenue is usually generated from rent and not from re-selling the property. Most REITs are equity REITs.
An example, Company B is an equity REIT and it buys an apartment complex from the money that it has acquired from its investors. Company B then goes out to rent the individual apartments to different tenants. Company B manages this property and collects rent from tenants every month and pays dividends to its investors. Company B in that case is considered as an equity REIT.
Mortgage REITs
Also known as mREITs, mortgage REITs usually lend money to owners of real estate through mortgages, loans or acquisition of mortgage-backed securities.
For example, Company P is a mortgage REIT and lends money to Company O, which is a real estate developer. Company P which is a REIT will earn its income from the interest generated from the loan that it gave Company O, the real estate developer. Generally, the profits are higher in the case of rising interest rates.
However, Mortgage REITs tend to be riskier than equity REITs because on one hand there is the interest that they earn on the mortgage loans but at the same time, there is the cost of funding these loans. When interest rates go up, these types of REITs are more likely to be affected.
Hybrid REITs
These types of REITs combine the investment strategies of both equity and mortgage REITs. They own and operate both real estate properties and commercial property mortgages.
By Trading Status
Publicly traded REITs
Like stocks and ETFs, these types of REITs are publicly traded on a stock exchange. You can buy them using a normal brokerage account.
According to Nareit (National Association of Real Estate Investment Trusts), U.S. REITs own nearly $4.5 trillion of gross real estate with public REITs owning $3 trillion in assets.
These types of REITs tend to have more transparency and better governance. Their stocks are usually quite liquid, meaning that investors can easily buy and sell them. Because of this, many investors prefer investing in these kinds of REITs.
Public non-traded REITs
These REITs are registered with The Securities and Exchange Commission, SEC but are not available on an exchange.
They can however be bought from a broker that participates in offering public non-traded REITs. If you're an investor looking to venture into public non-traded REITs, you can check out Nareit's online database where they maintain records of REITs by listing status.
These REITs are usually highly illiquid because they aren't traded publicly.
Private REITs
Private REITs are companies that are not registered under The Securities and Exchange Commission, SEC and whose shares aren't traded on national stock exchanges. Essentially, private REITs can only be sold to institutional investors.
Because such REITs have fewer disclosure requirements, this makes it hard to evaluate their performance on the stock market. As a result, many investors don't prefer these kinds of REITs as they are subject to more risk.
What qualifies as a REIT?
For a company to qualify as a REIT, it must meet the following qualifications:
- Invest at least 75% of its total assets in real estate
- Derive at least 75% of its gross income from rents from real property, interest on mortgages that finance real property or from sales of real estate
- Pay at least 90% of its taxable income in the form of shareholder dividends each year
- Be an entity that is taxable as a corporation
- Be managed by a board of directors or trustees
- Have at least 100 shareholders after its first year of existence
- Have no more than 50% of its shares held by five or fewer individuals
How to invest in REITs
Here's how you can get started:
Individuals
As an individual, you can buy shares in a REIT that’s publicly listed on major stock exchanges.
Investors
As an investor, you can also buy shares in a REIT mutual fund or exchange-traded fund (ETF).
It is important to consult a financial advisor or planner before you invest in any REIT so that you can align your investments with your financial goals. If you'd like to get in touch with one of our qualified financial advisors, contact us here.
Pros and c of investing in REITs
Investing in REITs can not only be profitable, but they can also help you diversify your investment portfolio.
But before you jump in as an investor, here are some pros and cons to consider.
Pros
- Portfolio diversification: Investing in REITs can help you diversify your investment portfolio. This means that you face less risk as an investor as your money is spread across different assets.
- Dividends: With REITs, you are assured of receiving consistent dividends as REITs are required by the law to pay out at least 90% of their income to dividends.
- Corporate tax: Because REITs are required to pay out 90% of their income to dividends, they are not required to pay corporate tax. This therefore means higher payout for the investors.
- Liquidity: Buying and selling REITs takes less time as compared to buying or selling an investment property. You can literally buy or sell your shares at the click of a button.
- Tangibility: REITs are usually investments in the form of physical property. For some investors, the ability to see an investment physically puts them at ease. Also, more often than not, real estate and other tangible assets usually appreciate in value over time.
Cons
- Taxes on dividends: As much as REITs are not subject to corporate tax, the taxes charged on dividends are much higher than the taxes charged on regular income. Most times, dividends are taxed at the same rate as long-term capital gains.
- Potential high fees and risks: Before you invest in REITs, find out the important things like interest rates, tax laws and geography of the properties. REITs can charge high management and transaction fees leading to lower payout of dividends to the investors.
- Sensitive to interest rates: Just like many other investments, REITs are sensitive to changing interest rates. A rise in interest rates can cause a disruption in the price of REIT stocks. It is important to note that the value of REITs is tied inversely to the Treasury yield. And so when the Treasury yield rises, the value of REITs are likely to fall.
- Value can be influenced by trends: REITs can at times be influenced by trends which may not always be a great thing. For example, an investor who's bought REIT shares at a mall that mostly houses fast food joints and then a health craze kicks in, their investment could take a hit. REITs can also be influenced by smaller trends like location or property type.
- Long-term investment: REITs are usually a preferred choice for people looking to have long term investments. As they are affected by tax changes and interest rates, this can make them riskier for people looking for short term investments.
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Sources
https://www.reit.com/what-reit/types-reits/guide-mortgage-reits
https://www.reit.com/what-reit
https://www.investopedia.com/terms/r/reit.asp
https://www.sofi.com/learn/content/reit-investing-pros-and-cons/
https://www.fool.com/investing/stock-market/market-sectors/real-estate-investing/reit/
