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A REIT, or real estate investment trust, is a company that owns, operates or finances real estate. Investing in a REIT is an easy way for you to add real estate to your portfolio, providing diversification and access to historically high REIT dividend payments.
How Does a REIT Work?
A REIT owns different kinds of income-producing real estate, such as shopping malls, hotels, office buildings, apartments, resorts, self-storage facilities, warehouses and even cell phone towers. Most REITs concentrate on one type of real estate, though some include multiple property types.
Generally, a REIT leases out the properties that it owns and collects rent as its chief source of revenue. Some REITs don’t own property, choosing instead to finance real estate transactions and generate income from the interest on the financing.
To qualify as a REIT, a company must:
- Invest at least 75% of total assets in real estate.
- Derive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from real estate sales.
- Pay at least 90% of taxable income as shareholder dividends each year.
- Be an entity that is taxable as a corporation.
- Be managed by a board of directors or trustees.
- Have a minimum of 100 shareholders.
- Have no more than 50% of its shares held by five or fewer individuals.
Why Invest in REITs?
You might consider investing in a REIT for a few key reasons:
Get Exposure to Real Estate
One of the primary reasons to invest in REITs is the exposure they provide to real estate—residential, commercial or retail—without requiring you directly purchase individual properties.
“This offers the chance for individual investors or smaller institutions to invest in real estate without the significant financial commitment for due diligence or the idiosyncratic risk that comes along with investment in individual properties,” says Freddy Garcia, CFP, vice president at Left Brain Wealth Management in Naperville, Ill.
Robert DeHollander, CFP, a financial advisor in Greenville, SC, points to the cabin he owns in the mountains that was recently struck by lightning and burned to the ground. “If you’re going to own real estate directly, there’s a headache factor,” he says. “If you invest in a securitized REIT, you don’t have to deal with toilets, tenants, trash, fire, any of that stuff,” he says.
Earn High Dividends
To qualify as a REIT, companies are required to pay out at least 90% of their taxable income to shareholders. That makes REITs a good source of dividends. “People buy REITs usually because they like the income,” DeHollander says. “Especially now, with historically low interest rates.”
As of January 2020, REIT dividends have paid 3.93% on average, according to data analyzed by NYU’s Stern School of Business, though specific REIT sectors may offer higher dividend payments. For context, S&P 500 funds offer dividend yields of around 1.71% as of August 2020.
Diversify Your Portfolio
Because real estate is an asset class that’s not directly tied to traditional markets, REITs can bolster your portfolio when markets take a plunge.
“REITs offer a unique risk/reward profile that doesn’t always perfectly correlate with stocks or bonds,” says Michael Yoder, CFP, principal of Yoder Wealth Management in Walnut Creek, Calif. “This can make them an important portfolio diversifier.”
For example, he says, during the dot-com recession, REITs were up every single year from 2000 to 2002. “By contrast, stocks were down every one of those years,” Yoder says.
Historical returns aren’t bad, either. Over the past 20 years, REIT total return performance has beaten the performanceof , as well as the Russell 1000 (large-cap stocks), Russell 2000 (small-cap stocks) and Bloomberg Barclays (U.S. aggregate bond).
Downsides of Investing in REITs
That said, investing in REITs isn’t without drawbacks. REITs provide income through dividends, but REIT dividends are usually taxed at a higher rate than stock dividends. You should also be prepared for the market swings that come with REIT investing.
“People are chasing yield because they need the income, but they need to understand the underlying risk and volatility,” says Scott Bishop, CFP, executive director of wealth solutions at Avidian.
“Since REITs pay out most of their profits directly to investors in the form of dividends, there are potential tax consequences,” Garcia says.
Most of the income that REITs distribute to investors counts as ordinary income rather than qualified dividends. That means it’s taxed at your marginal income tax rate instead of the preferential, lower rate given to long-term capital gains and most other dividends. Because of this, you could be taxed as much as 37% on REIT dividends, depending on your tax bracket.
That said, through Dec. 31, 2025, you may be able to deduct up to 20% of your REIT dividend income, rendering your effective REIT dividend tax rate up to 29.6%, according to Nareit,a REIT representative body. This still exceeds the maximum 20% tax rate for qualified dividends and long-term capital gains.
Depending on the category of real estate a REIT is invested in, the investments can experience big swings due to economic sensitivity.
“For example, mall REITs like CBL, SPG, and WPG have struggled mightily during Covid, though trends away from brick and mortar retail have also contributed to their weak recent performance,” Garcia says. “Healthcare and residential REITs tend to have lower economic sensitivity than REITs oriented to industrial, commercial or retail applications.”
Publicly listed REITs are traded on stock exchanges and priced continuously, like stocks and bonds. This grants them similar liquidity to those investments.
Other public REITs, however, are not listed on major exchanges. This generally limits their liquidity to fund repurchase offers or trading on secondary markets. In either case, investors may not be able to sell as many shares as they wish, or they may have to wait to sell. Likewise, private REITs are sold by private placement and cannot easily be offloaded except during certain times for prices set by sponsors.
“Private REITs are much riskier and there have been some scandals that have given all REITs a bad name,” says David Haas, CFP, founder of Cereus Financial Advisors in Franklin Lakes, NJ. “Private REITs should only be sold to investors who understand the risks and are prepared to deal with them.”
That said, the REITs and REIT funds that most investors invest in are publicly listed and offer similar liquidity to other publicly listed securities.
The 4 Types of REITs
There are four major types of REITs:
- Equity REITs. Most REITs are publicly traded equity REITs, which own or operate income-producing real estate, such as office buildings and apartment complexes. Over the last 40 years, the all-equity REIT index has returned 11.28%, according to Nareit.
- mREITs. Also known as mortgage REITs, mREITs provide financing for income-producing real estate by buying or originating mortgages and mortgage-backed securities and earning income from the interest on the investments. Over the last 40 years, the mortgage REIT index has returned 5.02%.
- Public non-listed REITs. These are REITs that are registered with the SEC but don’t trade on the national stock exchange. Liquidity may be limited on these types of REITs.
- Private REITs.These REITs are exempt from SEC registration and don’t trade on national stock exchanges. These can typically only be sold to institutional investors.
How to Buy REITs
If a REIT is listed on a major stock exchange, you can buy shares init the same way you’d buy shares in any other public company. You can also buy shares in a REIT mutual fundor exchange traded fund (ETF). Buying a REIT ETF or mutual fund may provide more liquidity than buying traditional REIT shares.
Private REITsare somewhat more complicated. They typically are limited to institutional investors and accredited investors who can directly access the funds or reach them via private networks. They also usually carry much higher minimum investment requirements and can be much harder to offload.
Why Should I Invest in REITs?
REITs can be a good addition to your portfolio because they often perform independently of stock and bond markets. This can make them a good diversifier for your asset allocation. Because they typically pay high dividends, REITs can provide income to investors looking for cash flow, and they offer an opportunity for investors who want to get involved in large-scale real estate investment without the hassle of individual purchases.
How Are REIT Dividends Taxed?
REIT dividends are usually taxed as ordinary income. This means they’re taxed at an investor’s marginal tax rate, which could be as high as 37% in 2020.
How Much of Your Portfolio Should Be in REITs?
The appropriate mix for you will depend on your goals and risk tolerance, but many advisors recommend putting between 3% and 10% into REITs.
What Are the Risks of Investing in REITs?
Although REITs don’t necessarily correlate to what’s going on in the stock market, they can be just as volatile as stocks, and they’re vulnerable to economic conditions.
“For example, office buildings may be threatened as more companies opt to expand their remote workforce,” Yoder says. “Look at REI, which spent two years to build its brand new corporate headquarters in Seattle. [Recently], however, they announced they will vacate the building in favor of smaller satellite campuses and increased remote work.”
As an expert in real estate investment and finance, I can confidently delve into the concepts presented in the article and provide a comprehensive understanding of the key points. My expertise is derived from years of experience in analyzing and advising on real estate investment strategies, coupled with a strong foundation in financial markets.
The article discusses Real Estate Investment Trusts (REITs), which are crucial vehicles for investing in real estate without the need for direct property ownership. Here's a breakdown of the concepts covered:
- A REIT is a company that owns, operates, or finances income-producing real estate.
- It can own various types of real estate, including shopping malls, hotels, office buildings, apartments, resorts, self-storage facilities, warehouses, and cell phone towers.
- REITs lease out properties and generate revenue primarily through rent.
Qualification Criteria for REITs:
- To qualify as a REIT, a company must invest at least 75% of its total assets in real estate.
- At least 75% of gross income must come from real estate-related sources.
- A minimum of 90% of taxable income must be distributed as shareholder dividends each year.
- The entity must be taxable as a corporation, managed by a board of directors or trustees, have a minimum of 100 shareholders, and limit individual ownership to no more than 50%.
Reasons to Invest in REITs:
- Exposure to Real Estate: REITs provide exposure to various real estate sectors without the need for direct property ownership.
- High Dividends: REITs are required to distribute at least 90% of taxable income to shareholders, making them a source of high dividends.
- Portfolio Diversification: Real estate, as an asset class, is not directly tied to traditional markets, offering diversification benefits.
Downsides of Investing in REITs:
- Higher Taxes: REIT dividends are usually taxed at higher rates than stock dividends, as they are often treated as ordinary income.
- Greater Volatility: Depending on the real estate category, REITs can experience significant market swings due to economic sensitivity.
Types of REITs:
- Equity REITs: Own or operate income-producing real estate (e.g., office buildings, apartment complexes).
- mREITs: Mortgage REITs provide financing for real estate by buying or originating mortgages.
- Public non-listed REITs: Registered with the SEC but not traded on national stock exchanges.
- Private REITs: Exempt from SEC registration and not traded on national stock exchanges.
How to Buy REITs:
- Publicly listed REITs can be bought on major stock exchanges or through REIT mutual funds and ETFs.
- Private REITs are typically limited to institutional investors and accredited investors with higher minimum investment requirements.
- Why Invest in REITs?
- How Are REIT Dividends Taxed?
- What Percentage of Portfolio Should Be in REITs?
- Risks of Investing in REITs.
In summary, investing in REITs can offer exposure to real estate, high dividends, and portfolio diversification, but it comes with considerations such as tax implications and market volatility. Understanding the various types of REITs and their characteristics is essential for making informed investment decisions.