Real estate investing can be a great way to diversify your portfolio, but sometimes real estate assets can require too much capital. Fortunately, there are other ways to invest in real estate, including learning how to invest in REITs (real estate investment trusts).
Here's everything you must know about REITs and how they work.
What Is a REIT
REITs, or real estate investment trusts, are companies that own real estate. It's typically commercial real estate they own, and many companies own them and run them too. Commercial real estate properties are typically income producing real estate that pays investors dividend income in the form of rental income or mortgage interest, depending on the type of REIT chosen.
There are publicly traded REITs and non traded REITs. Publicly traded REITs trade on the stock exchange, and you can invest in them using your traditional brokerage account. Non traded REITs or private REITs aren't bought and sold on the stock exchange. You purchase shares through a financial advisor associated with the REIT.
To qualify as a REIT, companies must:
- Invest 75% or more of their cash and assets in real estate
- Have at least 75% of their income come from real estate
- Return at least 90% of their profits to shareholders as dividend income
- Not have five or fewer investors own more than 50% of the shares
As an investor, you can invest in equity REITs or mortgage REITs. Equity REITs invest in a property's equity. Investors earn regular dividends, usually as rental income, monthly or quarterly, and a prorated amount of the property's capital appreciation.
If you invest in mortgage REITs, you play the role of lender, lending money to real estate investors and builders. The real estate bought with the funds is the collateral for the loan, and investors earn dividends from the interest paid on the mortgage.
Any investor (beginner or experienced) can benefit from investment portfolio diversification by adding REITs to their portfolio.
Making Money With REITs
Making money with REITs is the goal, but like any investment in your investment portfolio, there's never a guarantee you'll make money. However, diversifying your portfolio with stock market assets, REITs, bonds, and other commodities can help lower your risk of a loss.
REITs make money by collecting rental income or interest on a monthly basis. In the case of equity REITs, they also earn money from the equity buildup and capital appreciation. Then, when the REIT sells the property, they distribute the profits to the shareholders.
Each REIT pays dividends in different intervals. Most commonly, they pay dividends monthly, but some pay dividends quarterly or even annually, so always read the fine print. You can cash out your dividends in most cases but may also be able to reinvest them to compound your earnings if you wish.
How to Choose the Best REIT for You
Choosing the right REIT investments mean making a lot of decisions. First, you must choose between publicly traded REITs and non traded REITs. To make this decision, you should determine your investment goals, timeline, and dividend needs.
As you evaluate the REITs themselves, you should focus on the company's growth, metrics, and historical performance. Of course, any company can call itself a REIT, but it takes careful due diligence to ensure the company is legit, has a positive past performance, and is experienced enough to bring in earnings for retail investors.
Keep in mind as you buy and sell REITs, you should know the company's requirements. Publicly traded REITs are more liquid than non traded REITs, so always pay close attention to the timeline. Real estate investments can require you to tie up your funds for several years without the option for early redemption, so always look at the big picture.
Types of REITs
As you choose the best publicly traded REIT, public non traded REITs, or private REITs, pay close attention to the types of REITs they are or the type of real estate assets they invest in before adding them to your investment portfolio.
Retail REITs invest in shopping malls, strip malls, and freestanding retail establishments. Most retail centers you frequent are owned by a REIT. Before you invest in a retail REIT, consider the retail industry at the time. Is retail thriving or struggling?
Because most of your income will come from rent, you want to invest in a thriving market. If you invest in a mall, for example, with weak anchor stores, they may be unable to keep up with their rents, leading to default and a loss for you.
Residential REITs invest in multi-family units that the real estate companies rent out to individual renters. For example, they might own an apartment building or multi-family unit, collecting rents and sharing them with REIT shareholders.
It's best to look in areas with high rents and a high need for rental properties. Residential REITs perform best in areas where residential housing is unaffordable, causing more people to rent versus buy. A close look at the local real estate market will help you determine which areas are best for this.
Healthcare REITs can be a great way to invest in real estate. However, it can be risky too. If you add healthcare REITs to your portfolio, make sure you diversify. In other words, don't invest in all hospitals or all medical offices. As healthcare needs and expenses rise, so does the viability of certain establishments. Like any investment, diversify your risk to offset the chance of a total loss.
Office REITs invest in office buildings. The office building tenants pay the REIT rent, which the REIT passes along to shareholders. As with any commercial real estate investment, look at the area's viability.
What is the need for office real estate in the area? What is the unemployment rate? How long are companies signing leases for? The higher the need for office space, the lower the unemployment rate, and the longer the leases, the lower your risk becomes.
Mortgage REITs invest in the debt side of income producing real estate. Rather than owning a portion of the office or residential building, you lend money to the real estate investor or builder. They use the funds to buy real estate, which is the collateral for the investment.
Shareholders earn a portion of the interest collected on the mortgage REIT, but the timeline for the investment can be longer since most investors take long term loans. Some REITs, however, offer short-term loan options that mature in 6 to 12 months.
Equity REITs invest in a property's equity. Investors of equity REITs earn rental income as dividends and earn a portion of the property's equity or capital appreciation when the REIT sells the real estate.
Hybrid REITs own both equity investments and debt investments, aka mortgage REITs. This can be a key way to diversify your portfolio without investing in multiple REITs. You kill two birds with one stone by diversifying your funds across debt and equity investments.
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REIT Trading Statuses
Understanding the REIT's trading status is crucial because it affects how you can buy and sell REITs and how long you might need to hold onto them based on their liquidity.
Publicly traded REITs are traded on the standard stock exchanges, and anyone can buy or sell them during regular trading hours. As a result, they are typically more transparent than other asset classes, and they are much more liquid since there is a secondary market ready to buy REITs at any time.
Each publicly traded REIT is governed by the Securities and Exchange Commission too, which may give you more reassurance.
Public non traded REITs are also governed by the SEC, but they aren't nearly as liquid. There isn't a secondary market ready to buy the investments at any given moment. So you could be tied up in the investment for many years.
Public non traded REITs often have valuation delays, as it can take over a year to get a true value.
Private REITs are the riskiest of the three options because they aren't registered with the SEC, and they are even more difficult to value. Since there isn't a market waiting to buy them off investors, your capital is often tied up for more extended periods, and the risk of loss is much higher without the SEC registration.
- Low capital requirements
You don't need hundreds of thousands of dollars to invest in real estate. You can invest with a fraction of the investment's value and still be a real estate investor.
Most REITs pay dividends as they are required to pay out 90% of their profits to shareholders. As a result, you might receive monthly, quarterly, or annual dividends.
- Capital appreciation and capital gains
You might earn capital appreciation or capital gains if you stick out the investment through its lifetime. When real estate companies sell the real estate they invested in, the shareholders earn a prorated portion of the profits.
- Diversified portfolio
Real estate can be a great way to diversify your portfolio, but sometimes it's out of reach for the typical retail investor. Whether an equity REIT or mortgage REIT, you can diversify your portfolio from the standard stocks and bonds by investing in REITs.
- Tax liabilities
REIT investors pay ordinary taxes on any dividends earned from a REIT. This can significantly increase your taxable income and your overall tax liabilities. It's best to talk to your tax advisor about the risk before investing.
- Can be a fad
Depending on the type of commercial property you invest in, you might be at risk of a fading fad. For example, if you invest in REITs that invest in cupcake shops and cupcake shops suddenly become less popular, you might find yourself with investments in real estate with non-paying tenants.
- Your money is tied up for a long time
Your investment capital can be tied up for a long time with REITs. While they have the potential for high dividend yields, you might not see the full return on your investment for 5 - 8 years.
REIT Risks vs Rewards
As you consider your real estate investing strategy, you should look at the risk vs reward when investing in REITs. Evaluate what you stand to lose if the investment falls apart (risks) and compare that to the potential rewards (earnings) to decide if it's a good fit for your investment strategy.
5 Best REITs in 2023
Preferred Apartment Communities or APTS is a Maryland corporation that invests in apartment buildings, but they also have some investments in select grocery store establishments. Their goal is to invest in stable multi-family real estate properties and multi-family real estate loans.
The Blue Rock Residential Growth REIT is a publicly traded REIT focusing on high-growth area apartment building investments. They focus on relationship-based investments along with ways to improve operations and the value of their chosen properties.
The Nexpoint Residential Trust focuses on real estate investments in the Sunbelt and mostly invests in undervalued properties. They work to increase the property's value, providing renters with a stable and solid place to live while also providing their shareholders with a return on their investment.
The Independence Realty Trust owns and operates multi-family residential buildings throughout the United States. They focus on operational performance while providing shareholders with a decent return on their investment by investing in multi-family buildings in strong areas.
Retail Value is a publicly traded REIT listed on the NYSE. It owns assets in the US and Puerto Rico, and they have a property management company operating its properties. They focus on earning profits through both solid operations and the sale of assets at a solid gain.
How Much to Invest
How much you should invest in a real estate investment trust depends on your gross income, financial plan, and investment strategy. No two investors will have the same money they can or want to invest. It also depends if you invest in a REIT that is only for accredited investors (requires much higher investment minimums) or non accredited investors (allows much lower investment minimums).
How Much Money Do You Need to Invest in REITs?
Each REIT has a different minimum investment requirement. Some can be as low as $100, and others can be as much as $25,000. Read the fine print to find out a REIT's minimum investment requirement and see how it fits in with your portfolio.
Can You Lose Money on a REIT?
You can lose money on any investment, including a REIT. There's never a guarantee that real estate will appreciate. While historically, it performs well, you should never assume that you'll make money on a REIT. Diversifying your portfolio can reduce the risk of a total loss.
Are REITs Safe During a Recession?
Real estate investment trusts invest in real estate, which usually withstands a recession or at least bounces back quickly. But, like any investment, there are risks and rewards of investing during a recession or holding onto them during a recession, so always do your due diligence.
What Is the Average Return of REITs?
Like any investment, REIT returns can fluctuate, but on average, they have a return of 10% - 11%, which often beats the stock market returns.
Are REITs Short or Long-Term Investments?
Most REITs are long-term investments and can tie up your funds for as long as 5 to 8 years, but there are some short-term options, especially if you are willing to help real estate investors and builders finance real estate, you may find shorter term loans that mature quickly. Equity REITs, though, usually have a longer timeline.
There are many ways to invest in REITs, so taking your time and learning how to invest in REITs is important. Assess any REIT's risk and reward, timeline, and historical performance before investing to give yourself the best chance at decent earnings. Learn more by signing up and visiting our blog.
I am an experienced real estate investment enthusiast with a deep understanding of various investment vehicles, including Real Estate Investment Trusts (REITs). Over the years, I have actively engaged in real estate investment, carefully analyzing market trends, evaluating different types of REITs, and exploring their risks and rewards. My knowledge extends to both publicly traded and non-traded REITs, as well as various categories such as equity REITs, mortgage REITs, and hybrid REITs.
Now, let's delve into the concepts mentioned in the article about REITs:
Real Estate Investment Trusts (REITs):
Definition: REITs are companies that own and, in many cases, operate income-producing real estate. They offer investors the opportunity to invest in real estate without having to directly own the properties.
Types of REITs:
- Equity REITs: Invest in a property's equity, providing investors with regular dividends and a share of the property's capital appreciation.
- Mortgage REITs: Act as lenders, providing funds to real estate investors and builders. Investors earn dividends from the interest paid on the mortgage.
Qualification Criteria for REITs: For a company to qualify as a REIT, it must:
- Invest at least 75% of its cash and assets in real estate.
- Have at least 75% of its income come from real estate.
- Return at least 90% of its profits to shareholders as dividend income.
- Not have five or fewer investors own more than 50% of the shares.
- Publicly-Traded REITs: Trade on stock exchanges, providing liquidity and transparency.
- Public Non-Traded REITs: Governed by the SEC but less liquid, with potential valuation delays.
- Private REITs: Riskier, not registered with the SEC, and often lack liquidity.
Advantages of REITs:
- Low capital requirements.
- Regular dividends.
- Potential for capital appreciation.
- Portfolio diversification.
Disadvantages of REITs:
- Tax liabilities on dividends.
- Susceptible to market trends and fads.
- Capital tied up for an extended period.
Choosing the Right REIT:
Factors to Consider:
- Investment goals, timeline, and dividend needs.
- Company's growth, metrics, and historical performance.
- Differentiate between publicly traded and non-traded REITs.
Types of REITs:
- Retail REITs: Invest in shopping malls, strip malls, and freestanding retail establishments.
- Residential REITs: Invest in multi-family units, focusing on areas with high demand for rental properties.
- Healthcare REITs: Invest in healthcare-related real estate, requiring careful diversification.
- Office REITs: Invest in office buildings, with considerations for market viability.
- Mortgage REITs: Invest in the debt side of income-producing real estate.
- Hybrid REITs: Own both equity and debt investments, offering portfolio diversification.
Making Money with REITs:
- REITs generate income through rental payments, mortgage interest, and capital appreciation.
- Dividends are paid out at different intervals, usually monthly, quarterly, or annually.
How to Choose the Best REIT:
- Consider investment goals, timeline, and dividend needs.
- Evaluate the company's growth, metrics, and historical performance.
- Be aware of liquidity differences between publicly traded and non-traded REITs.
REIT Risks vs Rewards:
- Evaluate the risk vs reward when investing in REITs.
- Consider the potential loss if the investment fails versus the potential earnings.
5 Best REITs in 2023:
- APTS (Preferred Apartment Communities): Focuses on stable multi-family real estate properties.
- BRG (Blue Rock Residential Growth REIT): Targets high-growth area apartment building investments.
- NXRT (Nexpoint Residential Trust): Invests in undervalued properties, mainly in the Sunbelt region.
- IRT (Independence Realty Trust): Owns and operates multi-family residential buildings throughout the U.S.
- RVI (Retail Value): Listed on the NYSE, with a focus on assets in the U.S. and Puerto Rico.
How Much to Invest in REITs:
- Depends on gross income, financial plan, and investment strategy.
- Minimum investment requirements vary among different REITs.
- Minimum Investment: Varies among REITs, ranging from as low as $100 to as high as $25,000.
- Risk of Loss: Like any investment, there is a risk of loss, and returns are not guaranteed.
- Safety During a Recession: REITs invest in real estate, which tends to withstand or recover quickly from recessions.
- Average Return: On average, REITs have a return of 10% - 11%.
- Investment Duration: Most REITs are long-term investments, but some short-term options exist.
Investing in REITs requires careful consideration of risk and reward. Conduct thorough due diligence, assess historical performance, and align your investment strategy with your financial goals. Whether you're a beginner or an experienced investor, the diversification benefits of including REITs in your portfolio can be significant. Stay informed and make well-informed decisions to maximize your potential earnings in the dynamic real estate market.