What is REIT?
A REIT or Real Estate Investment Trust refers to a company that owns, finances, and operates income-generating real estate. They are similar to mutual funds and offer a steady income for investors. However, they provide little capital appreciation. Public traded REITs are highly liquid and similar to stocks, which make them quite different from brick-and-mortar real estate investments. Through REITs, individuals do not have to buy, finance, or manage any physical property themselves to earn dividends from real estate investments.
REITs focus on specific real estate sectors, with some exceptions being diversified. Those specialty REITs hold different types of properties. Most REIT companies generate income by leasing space and collecting rent on the real estate it owns. This income is the base income for shareholder’s dividends. REITs are required by law to pay their shareholders a minimum of 90% of the taxable income, with most paying out 100%. Although it is a plus for a dividend investor, it severely limits the REIT stock’s capital growth.
Consequently, shareholders are required to pay income taxes on the dividends they receive. Mortgage REITs are also known as mREITs, finance real estate instead of owning them directly. Investors earn the income from the interest they receive on these investments.
Why invest in REIT
Investors have several reasons to invest in REITs; you can see them below:
- Stocks traded on major exchanges: REITs are similar to stocks and are traded on major exchanges around the world, offering investors easy access. For instance, Both the NYSE and NASDAQ have the majority of US-based REITs trading on their exchanges. Investors can purchase shares through a FINRA registered broker to invest in publicly-traded REITs.
- Usually, high dividend yield: The dividend yields of REITs have always produced a steady stream of income through both stable and unstable market conditions.
- Transparency: The REIT’s performances and outlook are all monitored by business and financial media, as well as by independent directors, auditors, and analysts. This oversight provides more than one barometer of a REIT’s financial status and condition and provides investors with a measure of protection.
- Liquidity: Since REIT shares are publicly listed on major stock exchanges, its liquidity is high.
- Portfolio diversification: REITs have low correlation with other stocks and bonds, providing a great way to diversify one’s portfolio
- Competitive long term performance: REITs have generated more long-term returns to several stocks in the market.
REITs are regarded as total return investments and typically provide high dividends as well as the potential for long term capital appreciation. The overall long term returns of REIT stocks are similar to that of other value stocks, which far exceeds the profits of other conservative instruments, like bonds.
There are four main categories of REITs, as described in brief below.
- Private REITs: These are REITs whose shares are not traded on any national stock exchange and are exempt from SEC registration.
- Equity REITs: The majority of REITs fall under this category. They are publicly traded and own or operate income-producing real estate. They are known as REITs in the market at large.
- mREITs: Mortgage REITs purchase or create mortgages and mortgage-backed securities to provide financing for income-producing real estate. They earn income from the interest on the investments they make.
- Public Non-Listed REITs: Public Non listed REITs, also known as PNLRs, do not trade on any national stock exchange but are still registered with the SEC.
How to Invest in REITs?
- Buying shares of REITs: Investors may purchase shares in REITs just like any other public stock, as they are listed on major stock exchanges.
- Shares in a REIT mutual fund or exchange-traded fund (ETF): Investors can also purchase shares in either REIT ETFs or REIT mutual funds. According to reports, the total number of individuals who have invested in REITs through various financial funds, such as retirement savings, reaches almost 87 million.
- Private REITs and Public non-listed REITs: Besides the above options, investors can invest directly in public non-listed REITs as well as private REITs.
REITs in your portfolio: pros and cons
Pros of investing in REITs
- Liquidity: REITs are traded in all major US stock exchanges everyday, which consists of more than 200 REITs, offering high liquidity.
- Diversification: REITs offer a new asset class to investors outside of the typical commodity, equity, cash, and debt categories. Adding REIT’s to one’s portfolio would help diversify the risk as they do not have much correlation with the other types of assets.
- Stable cash flow through dividends: REITs are required to distribute at least 90% of their earnings in the form of dividends. Investors can thus be sure about a good income ratio and a stable cash flow for them.
- Attractive, risk-adjusted returns: Public REITs provide risk-adjusted returns and have experienced less volatility than even the S &P 500 over the last four decades. The dividends from REITs can provide price support in down markets providing decent returns during a turbulent environment.
Cons of Investing in REITs
- Low growth: REITs drop out from a growth challenge, as they are required to distribute a large chunk of their earnings as dividends to investors.
- Profits taxed as regular income: Investors are required by law to pay income tax on the annual fixed income they receive. Treating dividends as a personal income comparing to a capital gain in regular stocks may be a disadvantage for investors falling in higher tax brackets.
- High management and transaction fees: Compared to most stocks and bonds, many REITs have high management and transaction fees.