Real estate has a reputation as a relatively safe and profitable investment option. It isn’t always an easy game to break into, though. Saving up for a down payment on a property is challenging, as is scoring funding for renovations to flip or get ready to rent out.
Fortunately, you can invest in the real estate market without saving tens- or hundreds of thousands of dollars for a down payment, renovations, or spending time managing property. Real estate investment trusts (REIT [pronounced ‘reet’]) help you invest in otherwise expensive property while diversifying your investment portfolio.
These types of investments buy and sell shares of real estate that produce income. Housing developments, data centers, shopping centers, condominiums, hospitals, and parking garages are a few examples.
Anyone can purchase REIT shares to invest in real estate without buying and managing property. Based on 2022 data, Nareit, a resource website for real estate companies, estimates that 50% of households (nearly 170 million Americans) invest in REIT stocks.
There’s a lot to learn about investing in REITs. Below, we discuss the top things you should know.
The Three Categories of REITs
- Equity
- Mortgage
- Hybrid
Equity REITs aim to profit off rentals, sales, and dividends.
Mortgage REITs aim to profit off mortgages and mortgage-backed securities. Mortgage-backed securities are a type of asset secured by a mortgage or collection of mortgages. These kinds of trusts can earn money through the interest collected on mortgages. Interest rate fluctuations significantly affect their earnings.
Hybrid REITs invest in a combination of mortgages and real estate.
Two Avenues to Invest
- Publicly traded
- Non-traded
You have two investment options in each of the three REIT categories. The first way is to buy publicly traded REITs. You purchase them like any stock or ETF (exchange-traded fund), using a brokerage account to buy shares on a stock exchange.
Non-traded REITs aren’t publicly traded on a stock exchange. You must work with a financial advisor or broker to invest. These types are more illiquid compared to publicly traded ones. You’ll either have to wait until the REIT liquidates its assets or lists its shares on a public exchange to access your money. You may find one that accepts early withdrawal offers, but it all depends on the terms of the REIT you invest in.
Earnings
REITs invest in assets that generate income, like commercial properties. You earn money on share price appreciation and dividends.
By law, REITs must pass down 90% of their income to shareholders through dividend payouts, making them a dependable income stream. Their dividend rate is higher than most fixed-income investments or equities. Additionally, they have low correlation with other assets, so they help you diversify your investment mix.
Risks
As with any investment, REITs carry some risk. Share prices of publicly traded REITs can experience dips since they fluctuate with the stock market. They may lose value even if the value of the real estate holds steady or increases. You’ll sell at a loss if you need to sell at all.
With non-traded REITs, factors like whether you’re investing in a property still in development, a finished property, or a tenant’s lease for their commercial property influence your risk.
As a rule of thumb, the shorter the lease term, the higher the risk. You never know how long it’ll take to find a new tenant once a lease is up for the current tenant.
Betting on property still under construction is another risk. You won’t have income from that property for the first few years while it’s incomplete.
Fees
Think of investing in REITs like investing in a mutual fund–it comes with management fees, just like investments in ETFs and index funds. You’ll incur varying management fees depending on the fund. Double-check with the broker or your financial advisor to learn about and discuss those extra charges.
Long-term and Illiquid
Generally, REITs are long-term commitments and highly illiquid. Since non-traded REITs aren’t on an exchange, you can’t sell at the click of a button. Your money could be tied up for years as you wait for public trading or asset liquidation.
Since publicly traded REITs fluctuate with the stock market, plan to hold onto them for at least three years. The longer you keep them, the more time you have to recover from stock market downturns.
Checking for Public or Non-traded
How can you be sure you invest in the publicly traded or non-traded REIT you intend? Publicly traded REITs have ticker symbols like stocks. Non-traded REITs don’t.
You may also search through a REIT directory on Nareit, filtering the list to look at all, only publicly traded, or only non-traded REITS. This site can help you research before working with a broker or advisor or independently investing in REITs.
Professional Help
Selection
An NC certified public accountant can help you pick wise REIT investments, researching the management team’s track record and compensation. For example, high-performing trusts typically rely on performance-based compensation for their management team.
Additionally, accountants can assist you with everything you need to know to minimize risks, from understanding trust-specific fees and dividend yields to surveying the management team’s strategies, leverage on the properties, and underwriting process.
Tax Considerations
Your gains/dividends from REIT investments are taxable at the standard income tax rate of up to 37%. However, you may deduct up to 20% of your yearly dividends when filing your taxes. Speak to your tax advisor for compliance in reporting and taking advantage of deductions.
REITs and Diversifying Your Wealth
Each REIT has a unique investment mix and strategy. You can invest in public REITs through any brokerage account. An individual broker or financial advisor can help you invest in non-traded REITs. REIT apps and websites can assist you in investing on your own.
REITs are a good investment for diversifying your wealth. They offer a steady income stream with low correlation to other assets.
Each trust has its pros and cons. Publicly traded REITs experience highs and lows with the stock market but allow you easier access to your money. Non-traded REITs are excellent for potentially higher yields. They can hedge against inflation but tie your money up for an extended time.
As with any financial step, consider your goals and how your next move will help you get closer to that goal. Liquidity or lack of volatility are usually the determining factors. A knowledgeable financial planning and investment management team can help you decide what’s best for your goals.
