Have you ever heard someone talking about REITs and then went into a daze imagining yourself counting grains of rice because the conversation was so daunting. In this blog, you will learn how to understand REITs in under 5 minutes to determine if it is a good investment for your portfolio so that you can join the conversation next time.
Disclaimer: I am not a REIT expert nor licensed to give individual investment advice. With that being said, this is for educational purposes only. Do your own research and speak to a professional specializing in investments if this is an investment vehicle that interests you.
What Is A REIT?
According to reit.com, a real estate investment trust (“REIT”) company owns, operates, or finances income-producing real estate.
How Does it work?
A REIT allows investors to buy shares of commercial real estate and earn income from shares through dividends.
The Three Main Types of REITs
There are three main types of REITS:
- Equity REITs- This is the most common type of REIT. It allows investors to collect money from physical real estate via rent instead of reselling the properties in the portfolio. The entities that operate this type of REIT buys, own, and manage the property.
- Mortgage REITs– A mortgage REIT is also known as mREITs. They lend funds to real estate owners and operators. This type of REIT is more sensitive when interest rates increase because they earn interest on their investments.
- Hybrid REITs– A hybrid REIT is a combination of Equity REITS which holds the physical real estate property, and Mortgage REITs which hold the mortgage loans for the properties.
What do REIT portfolios typically consist of:
- Apartment complexes
- Data centers
- Cell towers
- Healthcare facilities
- Hotels
- Infrastructure
- Office buildings
- Retail centers
- Self-storage
- Timberland
- And warehouses
Are REITs Appropriate for Long-Term or Short-Term Investments
REITs can be beneficial for any investor looking for short-term or liquid cash.
The Pros and Cons of REITs
Pros
- “REITs have historically outperformed the broader stock market during periods of high inflation.” ~reit.com
- You get a real stake in the ownership of the property
- You can earn income through rent and appreciation
- You can participate in real estate without investing large amounts of capital and dealing with the labor and management of the property.
- Your money is diversified through numerous properties
- REITs are required to distribute nearly 90% of their annual taxable income.
Cons
- Depending on your marginal tax bracket, you may pay high taxes because most REITs pay ordinary income taxes.
- Because the law requires REITs to pay their investors 90% of their profits, there is only 10% room for the company to grow by investing in additional properties.
- You don’t have a say so on which rental properties are purchased.
How to Get Started investing in REITs?
Research
Always do your research first; consult with a professional in that area of expertise if you encounter any information you don’t understand.
Management
Check the management and their team’s track record. How successful have they been with choosing great picks? Ask how they are compensated. If it’s based on their performance, then it’s a win-win for both of you.
Diversification
Using the portfolio examples above, ensure they are diversifying across real estate markets. If they are invested in one area, and that market underperforms, so will your money.
Earnings
Look at the earnings. Don’t look at the regular income numbers as it doesn’t always include property depreciation; instead, look at their funds from operations numbers and cash available for distribution.
How are REITs Taxed?
Each year shareholders will get a 1099-DIV form. This form will let the investor know if they will be paying ordinary taxes, capital gains, or a return on capital. Each person will be different because it depends on what type of REIT you are invested in, your marginal tax bracket, if the property was sold, etc. It is best to speak with a tax expert to understand how REITs will work for your situation.
How much of my portfolio should I allocate to REITs?
Multiple studies have shown that 5%-15% of REITs are appropriate to allocate for a portfolio. If you have about 35-45 years left before retirement, it is recommended to allocate 15%. If you have five years or less before retirement, investing closer to 5% is recommended. Speak to a financial professional to determine a good number to allocate.
Where Can I Find REIT Funds to invest in?
Here is a link from reit.com that lists a comprehensive list of REIT and publicly traded real estate companies that are members of Nareit
There you have it. You learned what REITs are, the pros and cons, how they are taxed, and how they can fit into your portfolio. I hope you have a basic understanding of what REITs are. I listed my sources below if you would like more in-depth information.
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Sources:
Hayes, A. (2022, June 23). REIT vs. Real Estate Fund: What’s the difference? Investopedia. Retrieved September 1, 2022, from https://www.investopedia.com/ask/answers/012015/what-difference-between-reit-and-real-estate-fund.asp
What’s a REIT (Real Estate Investment Trust)? What is a REIT (Real Estate Investment Trust)? | REIT.com. (n.d.). Retrieved September 1, 2022, from https://www.reit.com/what-reit
“Are REITs Beneficial During a High-Interest Era?” Investopedia, 16 Sept. 2015, www.investopedia.com/articles/investing/091615/are-reits-beneficial-during-highinterest-era.asp.
“The Basics of REIT Taxation.” Investopedia, 6 Aug. 2007, www.investopedia.com/articles/pf/08/reit-tax.asp.
“Landlord Vs. REITs: Pros and Cons.” Investopedia, 5 Sept. 2016, www.investopedia.com/articles/mutual-funds/090516/landlord-vs-reits-pros-and-cons.asp.
“List of REIT and Real Estate Funds.” REITs and Real Estate Investing: Real Estate Working For You | Nareit, www.reit.com/investing/reit-funds. Accessed 1 Sept. 2022.
“REIT Resources for Financial Professionals.” REITs and Real Estate Investing: Real Estate Working For You | Nareit, www.reit.com/nareit/advocacy/investor-outreach/resources-financial-advisors. Accessed 1 Sept. 2022.
“The REIT Way.” Investopedia, 26 Nov. 2003,