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What Is A REIT (Real Estate Investment Trust)?
If you're interested in getting into real estate investing, you've probably come across the term REIT.
What exactly is it and how does it work? You may ask. Let's get right into it.
A real estate investment trust (REIT) refers to a company that functions similar to mutual funds in that it owns, operates or provides financing for income generating real estate.
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. And yes, even you can become an investor. 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 is estimated that about 145 million Americans own REIT stocks.
Typically, What Assets Do REITs Own?
According to Nareit, "In total, REITs of all types collectively own more than $3.5 trillion in gross assets across the U.S., with public REITs owning approximately $2.5 trillion in assets, representing more than 500,000 properties. U.S. listed REITs have an equity market capitalization of more than $1.35 trillion."
Some common types of properties that REITs own include:
- Offices buildings
- Apartment complexes
- Medical facilities
- Data centers
- Cell towers
Are There Different Types Of REITs?
Yes there are. Here are six different types that you should know about.
By Investment Holdings
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.
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's 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.
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 an exchange. You can buy them using a normal brokerage account.
According to the National Association of Real Estate Investment Trusts, Nareit, REITs own more than $2.5 trillion of the $3.5 trillion in gross real estate assets from public listed and non-listed REITs.
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 Nareits 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 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:
- As an individual, you can buy shares in a REIT that’s publicly listed on major stock exchanges
- 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 Cons of Investing in REITs
Investing in REITs can not only be profitable but they can also help you diversify your investment portfolio.
It is estimated that REITs collectively hold about $3.5 trillion in gross assets. Ppublicly traded equity REITs account for $2.5 trillion in 2022.
But before you jump in as an investor, here are some pros and cons to consider.
- 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.
- 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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Bay Street Capital Holdings
Bay Street Capital Holdings is an independent investment advisory, wealth management, and financial planning firm headquartered in Palo Alto, CA. They manage portfolios with the goal of maintaining and increasing total assets and income with a high priority on managing total risk and volatility. Although many advisors may focus on maximizing returns, they place a higher priority on managing total risk and volatility.
Our founder, William Huston founded Bay Street after 13 years of supporting the United States' largest retirement plan ($650B) Thrift Savings Plan. He is recognized as Investopedia’s Top 100 Financial Advisors for 2021. In California, only two black-owned firms out of nineteen firms received this recognition. In Scottsdale Arizona, Ekenna Anya-Gafu CFP, AAMS is recognized among the Best Financial Advisors for his responsiveness, friendliness, helpfulness, and detail. Bay Street was founded to advocate for diverse and emerging fund managers and entrepreneurs. In 2021, Bay Street was selected as a finalist out of over 900 firms across the US in the category of Asset Manager for Corporate Social Responsibility (CSR).
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