REIT Investing For Beginners

Key Takeaways

  • REIT investing is a great way for entrepreneurs interested in real estate to get their feet wet in a new industry without getting in over their heads.
  • Investing in REIT assets is an alternative real estate investing method that doesn’t require significant capital to get started.
  • Investing in REITs vs real estate is a smart move for anyone considering breaking into the real estate industry.

Real estate investment trusts (REITs) award savvy investors an alternative to the traditional real estate investing approach. Whereas most real estate investors spend their time investing in physical real estate assets (buying and selling properties), those intent on investing in REITs are actually more interested in real estate companies. After all, that’s what REITs are: companies that invest in real estate, in one way or another. Nonetheless, REIT investing has proven it can benefit savvy investors, and you may want to consider adding an REIT to your own portfolio sooner rather than later.

What Is REIT Investing?

REIT investing isn’t all that different from trading on the stock market. If for nothing else, REITs are molded after the same mutual funds most people are familiar with, which means people can buy stock in them. More importantly, however, REITs award savvy investors the opportunity to take advantage of this historically prosperous real estate market, all with the ease that has become synonymous with participating in the U.S. stock market. In short, REITs allow investors to invest in real estate without actually buying physical assets, but rather investing in companies that invest in real estate.

Of course, not all stocks are REITs; there are certain criteria a company must meet to maintain its REIT status:

  • REITs must invest at least 75 percent of their total assets in real estate.
  • REITs must derive at least 75 percent of their gross income from one of at least three things: rental income, mortgage interest and real estate sales.
  • REITs must pay at least 90 percent of their taxable income to shareholders (dividends).
  • REITs must be a taxable corporation.
  • REITs must be run by either a board of trustees or directors.
  • REITs must have no less than 100 shareholders.
  • REITs can’t have the majority of their shares held by five or fewer shareholders.

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What is REIT investing?

Investing In REITs Vs Real Estate

As I already alluded to, investing in REITs allows investors to tap into the potential of the real estate industry without actually buying any physical assets. Instead of buying properties, as the average real estate investor would, those investing in REITs can actually invest in companies that invest themselves. REIT investors can capitalize on a market that has performed historically well without actually buying property, and instead buying what are essentially stocks traded on Wall Street. Physical real estate, on the other hand, will place a lot more control in the hands of the investor. Real estate investors naturally have a larger role to play in their own investments, which means their success and failure is mostly dependent on their own actions.

REIT Investing Pros And Cons

Investing in a REIT is just like investing in everything else: there are pros and cons that need to be addressed. I, however, am convinced the pros outweigh the cons. The real estate industry has performed historically well, and REITs are a great way for investors to tap into that potential, but don’t take my word for it. Weigh the pros and cons for yourself to come up with your own decision.

Pros

The pros of REIT investing are attractive enough to capture the attention of even the most entry level investors. That said, here are some of the best reasons most people start investing in REIT companies:

  • History Of Competitive Performance: Historically speaking, REITs have outpaced the returns exercised by traditionally traded U.S. stocks. In the extended period spanning from December 1978 to March 2016, total returns for exchange-traded U.S. equity REITs averaged 12.87 percent, whereas regular stocks averaged an 11.64 percent return per year, according to REIT.com.

  • Liquidity: Due to their placement on most major stock indices, REITs remain particularly liquid. Unlike physical real estate, the money investors have in REITs can be accessed relatively easily, and quickly. Therefore, transferring capital or reinvesting it isn’t difficult, at least compared to other investment vehicles.

  • Dividend-Based Income: In order to be classified as an REIT, companies need to pay at least 90 percent of their taxable income to shareholders. Otherwise known as dividends, the disbursement of funds that REITs are required to maintain are a great wealth-building vehicle for savvy investors. Dividends can really help grow an investor’s bottom line, and it certainly doesn’t hurt that REITs have to pay them.

  • Diversification: REITs enable investors to buy into not only different industries, but different REITs as well. Investors can invest in REITs that specialize in income-producing properties, or they can choose to invest in REITs that specialize in mortgages. On top of that, the REITs themselves are about as diverse an industry as any other; you can invest in everything from apartment buildings and commercial properties to movie theaters and malls.

  • Transparency: Regulated by the SEC, most REITS are required to divulge important information like earnings reports, so there’s a lot more transparency in the REIT world than in a number of other investment vehicles. For the most part, investors can know what to expect, outside of predicting the actual market itself.

Cons

What is REIT investing, if not for another way to diversify your portfolio? As an investment, REITs are not without their own caveats, however. Along with the pros, there are cons, and they are worth paying attention to. Here are some of the cons of investing in REITs you’ll want to consider before making any big decisions for yourself:

  • Limited Growth Potential: Since REITs are required to pay at least 90 percent of their taxable income to shareholders, their upside is limited be the very thing that makes them attractive to investors. REITs, therefore, have less money to reinvest in their own company, and are essentially their own worst enemy; it’s very much so a double-edged sword scenario.

  • Tax Exemptions: Some of the dividends shareholders receive are taxed as ordinary income, whereas most other dividends are taxed at a lower rate.

  • Interest Rates: The performance of REITs are inherently tied to interest rate trends. When rates increase, they eat into the profit margins of REITs. What’s more interesting, however, is that interest rates usually rise when the economy is strong enough to handle them.

  • Susceptible to Market Fluctuations: While the performance or REITs are generally tired to the real estate market, they can be influenced by volatile market fluctuations, from time to time.

Investing in REIT

Real Estate Investment Trust Types

REITs are nothing, if not diverse; they are simply one of the easiest ways for real estate investors to diversify their own portfolio. It is entirely possible to invest in commercial buildings, single-family homes, shopping malls, movie theaters, and just about any other form of income-producing properties. On top of that, however, there’s even more diversity offered up by the type of REIT you choose to invest in. You see, there isn’t just a single type of REIT you may choose to invest in, but rather four:

Equity REITs (REITs)

Equity REITs make up the majority of REITs publicly traded on today’s major market indices. More specifically, however, equity REITs are ubiquitous with companies that own or operate income-producing real estate. Therefore, anyone investing in equity REITs are actually investing in companies that, themselves, invest in portfolios of income-producing real estate. As companies that invest in physical real estate, it’s quite common for equity REITs to own and operate real estate in each major sector: office buildings, shopping centers, apartment complexes and more. And not unlike every other type of real estate investment trust, equity REITs are required by law to distribute at least 90 percent of their income to invested shareholders.

Mortgage REITs (mREITs)

Unlike their equity REIT counterparts, mortgage REITs do not invest in income-producing real estate, but rather in mortgages and mortgage-backed securities. You see, while equity REITs generate profits by investing in real estate, mortgage REITs act as the bank and collect interest on the financing they provide for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities. In other words, mortgage REITs invest in, well, mortgages. In offering the capitol other REITs need to invest in real estate, mortgage REITs can sit back and collect interest on the money they lend out.

Public Non-Listed REITs (PLNRs)

Very similar to traditionally listed REITs (mortgage and equity), public non-listed REITs own and operate (or finance) income-producing real estate portfolios. In fact, PLNRs operate much in the same way as regular REITs, with a few exceptions; namely; they aren’t traded on major securities exchanges and they face strict redemption restrictions levied by the U.S. Securities and Exchange Commission (SEC). Of particular importance, public non-listed REITs are required to make regular SEC disclosures, which impedes liquidity.

Private REITs

Similar to PLNRs, private REITs do not trade on national stock exchanges. However, unlike PLNRs, private REITs are exempt from SEC registration. As you may have assumed, the exemption does not subject private REITs to the same disclosure requirements as other REITs, which means they do not need to publicly announce financial reports. Instead of trading like the previous REITs, private REITs are generally reserved for institutional investors, and nobody else.

Have you been toying with the idea of REIT investing? Better yet, are you already investing in REITs and in need of some direction? Let us know how we can help you in the comments below.

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Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies
Real Estate Investing Strategies