Real Estate Investment Trusts (How to Invest in REITs)

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When you’re just getting started investing — or even if you’ve been at it a little while — it can be hard to wrap your head around all the different kinds of investing tools that exist. The confusion can feel a little scary: will investing in this asset or fund mean I might lose all my money?

We’re here to break it down and make it a little less intimidating. In this post, we’ll cover REIT investing. That stands for Real Estate Investment Trusts, and they’re essentially a way for ordinary consumers to make money off real estate without having to own and manage (or buy and sell) property themselves.

We’ll walk you through what REITs are, how they work, the different kinds of REITs that exist, and how you can get started investing in them. If you’re new to investing and want a broad overview first, read through this  article on how to invest in stocks as well as the piece on green investing to get a quick crash course.

You can read through the post top-to-bottom for a thorough look into REITs; or, feel free to click one of the links below to jump straight to the section you’re most interested in.

What are REITs?

Let’s start with a simple REIT definition. A REIT is a real estate investment trust. A REIT is a fund that pools investor money toward a property or collection of properties. REITs can vary in size and portfolio makeup, but let’s consider a pretty straightforward example. A REIT may fund a few self-storage locations across a number of cities. The company then collects revenue from customers renting space in the self-storage facility, and that revenue is then distributed among investors, often in the form of dividends.

There are a couple of main types of REIT to be aware of, which we will explain here.

Equity REITs

The most common variety of real estate investment trust is the equity REIT. Index REITs work basically in the way described above: the funds of all the shareholders are invested in property. That property is managed by a company who owns and operates it. A few examples of the kinds of property you might find in a REIT’s portfolio include:

  • Warehouses
  • Apartment complexes
  • Medical centers
  • Data centers
  • New construction
  • Hotels and hospitality

Essentially, anything that can be privately owned and operated can be part of a REIT’s holdings. That’s why REITs are such a massive portion of investment — they’re fairly easy to create. In fact, it’s estimated that American REITs contain about $3 trillion dollars collectively.

Note: REITs can also be structured as partnerships. The main difference here is how they are taxed when compared to index funds. REIT partnerships are taxed under Schedule K-1 which is a tax form used for small businesses, which can add some complexity when filing your annual tax return.

One other big difference in REITs is they can be bought as indexes (looks like this is mostly what you are talking about) but they can also be structured as partnerships – main thing to note is taxes – partnerships pay out with K1s which are a real pain if you buy a reit index it is taxed just like a stock and is much easier but they are very different in structure

Mortgage REITs

Mortgage REITs are less common, but you might still find them when hunting for investments. A mortgage REIT works by investing funds into bundles of mortgage debt, then allocating funds based on the interest payments on that debt. They’re more complicated than equity REITs, and have different pros and cons that are dependent on the state of the mortgage market. For instance, if interest rates drop, dividends from mortgage REITs might also drop.

It’s smart to note that there are also many hybrid portfolios, which incorporate both equity-based REIT dividends and mortgage REIT dividends. If you’re not sure which you want to invest in, you’ll probably want to speak with a professional broker who can walk you through the wisest ways to invest for your financial situation. We’ll talk about that more in a later section.

Something else you may want to be aware of is that REITs can either be publicly or privately held. That means there are some that are available to just about anyone with the capital to invest, and others that are entirely privately held by individual companies. If you’re not considering setting up your own REIT, it’s likely that you’ll only encounter the publicly traded options that are available on public exchanges.

How do REITs differ from other investment tools?

The feature of real estate investment trusts that most distinguishes them from other forms of investing is that they own or manage real estate or mortgages, as explained above. The world of investing is complicated, and it’s possible that other forms of investment also incorporate real estate to some degree; for instance, if you’re invested in Amazon, a portion of the returns you make from selling your shares might have been generated by the lucrative fulfillment center portion of their business.

However, the point of REITs is to focus entirely on real estate. That means that your investment will prosper or perish based on the fluctuations of the real estate market, rather than the fluctuations of a particular set of shares in equity, or individual company’s stock price. That brings us to the next thing you’ll probably want to know: the advantages and disadvantages of investing in REITs.

What are the pros and cons of investing in REITs?

As with any investment, the rewards of REITs can’t come without a bit of risk. Before you rush to ask your broker about REITs, let’s go over a few of the pros and cons that any investor should know about this investing tool.

Pros

  • REITs are easily available on the stock exchange. Unlike other ways of investing in property, REITs are much more accessible. Real estate can be one of the most prohibitively expensive forms of investing, and is a difficult market to break into — especially for those without the upfront capital to put a downpayment on a home. On top of that, fixing up and managing your property can add up to a full time job. REITs let you benefit from the lucrative real estate industry without all the upfront cost and labor (albeit at a slower and smaller rate).
  • They can be a steady source of dividend income. If you’re looking for a place to get started with dividend investing, REITs can be a handy choice. Like any dividend investment, the company will pay you out monthly or quarterly, so you have an extra source of passive income to add to your portfolio.
  • There is the potential to outperform other markets. This one comes with a pretty big condition: if real estate is doing better than other markets. That can sometimes be the case (they’re not making more land, as the old saying goes), but it can also mean that sometimes other parts of the market do better than real estate.com informs that real estate investments are not always correlated with other parts of the market, so you may outperform them — or simply add them to keep a steadier, diversified investment portfolio.

Cons

  • Real estate is subject to frequent fluctuation. Sometimes it’s a buyer’s market; sometimes, it’s a seller’s. Real estate can change with the winds, and it’s good to go into any investment with the knowledge that you could wind up losing money. While, in the long run, a solidly diversified portfolio may tend to grow, in the short-term you may have to weather a few storms.
  • Higher management fees. Depending on the REIT, you may face higher management fees. Recall that these are companies essentially doing the property buying and managing on their shareholders’ behalfs. They could charge a little extra for the work they have to put in.
  • Longer waits to access funds. Real estate sales can take a little while. If property managers and realtors are having a hard time renting or selling off properties, and you happen to be invested in those properties, you may not be able to access your funds as quickly as you may like. REITs are not a recommended place to store your emergency savings, for instance, for that reason. If you’re weighing the pros and cons of savings vs investing, REITs are much better suited as an investing tool.

Once you’ve got a clear picture of the advantages and disadvantages of REIT investing, you’ll probably be curious about how to get started. Let’s take a look.

How can I get started investing in REITs?

You can get started investing in REITs pretty much the same way you’d invest in any other fund or company’s stock. Here are the easiest ways that you can get started.

  • Purchase publicly listed REIT stock. As noted earlier, many REIT stocks are publicly listed. That means you can buy shares directly from the stock exchange, using an app or a website that allows you to buy stocks. This can be intimidating for some beginner investors, as there’s no middle-man and no expert guidance on what companies are smartest to invest in.
  • Invest with a broker. Brokers are professionals who handle investment portfolios for consumers. They should know exactly how to tailor your portfolio to your specific goals, needs, and risk tolerance. If you think REITs are a good option for your portfolio, talk to your broker about it — or, if you don’t have one, find a broker in your area and say you want to get started investing and you think REITs could be a good option for you. Many robo-investors also allow you to invest in REITs, or simply do it automatically depending on the portfolio options you select when making your account.
  • Through your retirement account. If you have a retirement account like a target date fund, IRA, or 401k, there’s a chance that you’re already invested in REITs without knowing it! Because, as we noted earlier, a REIT’s performance isn’t always correlated with other sectors of the market, they make for a solid diversifying option to keep your portfolio balanced.

Getting started investing in any area can be challenging. However, being informed is the best first step you can take. Once you feel comfortable in your knowledge of real estate investment trusts and how they work, you can start seriously thinking about investing.

Sources:

Investor.gov | REIT.com

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