What Is a Real Estate Investment Trust?
Real estate investment can be a capital-intensive undertaking. Depending on the location, properties can cost tens of thousands to millions of dollars. Then there is the risk of a losing investment. According to Money, 12% of house flippers lose or break even before they factor in repairs, and 28% make a gross profit on the sale but do not profit after paying for renovation costs.
The capital requirements and risks make it difficult for most investors to purchase property beyond their primary home. However, there are other options for people who want to invest in real estate.
One of the most accessible methods of property investment options is a real estate investment trust (REIT). REITs invest in properties directly or purchase interests in related areas, such as mortgages. They then issue shares, which investors can purchase just like they would buy stocks or other securities.
In other words, REITs make real estate investment possible for those without the capital or risk tolerance to buy properties directly. Here is a look at how REITs work.
Types of REITs
REITs come in different forms. Many focus on hotels, warehouses, apartment rentals, or other income-producing commercial properties. Other REITs earn income from related sources, such as mortgages.
Also, some REITs trade on public exchanges, while others function more like private funds, with only approved investors able to contribute capital.
Here is a look at the most common types of REITs.
According to the Financial Industry Regulatory Authority (FINRA), equity REITs focus on income-producing real estate. These trusts often purchase, invest in, or operate commercial and residential rental properties. Because their earnings come from consistent lease payments, it is easier to forecast earnings and calculate a return on your investment.
Shareholders get their portion of the rental revenue as dividends. The timing of these payouts can vary. Some equity REITs make annual dividend payments, while others pay out quarterly or monthly. According to Investopedia, equity REITs are more common than other varieties.
FINRA described mortgage REITs (mREITs) as trusts that provide funding to property owners and developers. They can provide loans directly to borrowers or invest in mortgage-related funds, bonds, or other debt instruments.
Shareholders get their portion of the income from mortgage interest payments or dividends from mortgage-related securities. As with equity REITs, mREITs provide reasonably predictable returns.
FINRA also points out that some trusts combine both mortgage and equity investments, providing shareholders with more diversification.
Publicly-traded REITs are listed on stock exchanges, where they trade like other public securities. The primary advantage of this investment type is liquidity. You can collect dividend payments while you own the shares, but you can also sell them at any time. Depending on the performance of your chosen REIT, your shares could increase in value over time, meaning you could earn a profit when you sell them.
Publicly-traded REITs need to be registered with the SEC and meet all reporting and transparency requirements to maintain their status.
Public Non-traded REITs
Public non-traded REITs must register with the SEC like their exchange-traded peers. Though they generate income in the same way and make dividend payments, these REITs aren’t listed on stock exchanges.
According to Kiplinger, the advantage of non-tradable REITs is that they aren’t affected by the stock market, so there is less danger that shares will lose value over time. Of course, it’s more challenging to sell shares in non-traded trusts.
Private REITs are not registered with the SEC, and they do not trade on public exchanges. The lack of regulation can present a risk for investors. However, FINRA explains that most private REITs are for institutional investors or accredited investors with verified access to significant amounts of capital.
Despite the potential financial requirements and need for extra due diligence, private REITs are otherwise similar to other trusts in terms of their investments and dividend payments.
How To Invest in REITs
You can decide if you would like to invest in REITs through a stock exchange or acquire non-tradable public or private shares. The choice will depend on the type of investment you would like to make, current market conditions, and your risk tolerance.
It is vital to understand the risks of real estate investing, including the danger of a market downturn, the risk of property mismanagement, the overall state of the economy, the level of inflation, and the need for liquidity in the investment.
A financial advisor can help you construct a portfolio using REITs and other asset classes. When choosing an investment expert to provide these insights, you should always find someone with a track record of success.
Qualifying as a REIT
According to the SEC, REITs must have 75% of their capital in real estate or cash and must distribute 90% or more of taxable income to investors. Though this is the primary requirement, the SEC also mandates other traits.
- All REITs need a board of directors.
- The trust must gain at least 100 investors within 12 months after establishment.
- Public REITs must file required reports with the SEC.
- Distribute ownership so that no five individual investors control more than 50% of the shares.
These regulations apply to SEC-approved REITs. Private REITs are subject to the same rules.
Are REITs Worth the Investment?
REITs are a unique investment product, but you might wonder if they are worth risking your capital. Here are the benefits these trusts provide.
- Access to the real estate market without purchasing physical property yourself;
- More liquidity than physical property;
- Regular dividend payments;
- The ability to diversify with multiple REITs;
- Access to commercial real estate projects.
You need to weigh these advantages against the potential drawbacks.
- Lack of control over property management and development decisions;
- Fewer tax advantages compared to physical real estate;
- Can be subject to fluctuations in both stock and real estate markets and interest rate decisions.
- REITs do not provide short-term profits. Share prices rarely spike, meaning profits primarily come from dividends.
REIT information from trusted sources can help you avoid (or at least understand) the potential drawbacks of investing in property trusts and give you the best chance for success.