What Is A Real Estate Investment Trust (REIT)?
There are many ways to invest in real estate. If you don’t have enough money to buy a single-family home, multifamily property or commercial building on your own, you might consider investing in a real estate investment trust, better known as a REIT.
A REIT, defined as a company that owns a portfolio of real estate, provides an opportunity for investors with less available cash to invest their dollars in real estate.
But how do REITs work and what exactly are they? Here are the answers to some of the most common questions investors have about these real estate-owning trusts.
What Is A REIT?
A real estate investment trust (REIT) is a company (or trust) that owns a portfolio of income-producing real estate. These trusts, made up of individual investors, can own any type of real estate, from apartment buildings, office properties and warehouses to hotels, single-family rentals, shopping malls and self-storage units. The key is that this real estate generates income, usually in the form of monthly rents.
REITs are attractive because they allow for passive real estate investing, meaning that investors can enjoy the returns of real estate without actually owning the physical apartment buildings, office properties or warehouses generating the profits.
You make money from REITs in the form of regular dividend payments. REITs earn income from the collection of rents and fees on the real estate they own. They then pay out a portion of this income to its investors as dividend payments on a regular basis, often quarterly or twice a year.
You can also earn money by selling your shares in a REIT. How much you earn from a sale will depend largely on whether the value of the real estate owned by the REIT has increased.
Common Types Of REITs
If you are interested in investing in a REIT, you can choose from several types, all of which specialize in different types of real estate.
A mortgage REIT invests in mortgages and mortgage-backed securities. These REITs earn income from the interest on these mortgages.
Commercial REITs own commercial properties such as hotels, office buildings, parking lots and self-storage units. These REITs generate income from the rent paid by tenants of these buildings.
Health care REIT
A health care REIT focuses on medical properties such as hospitals, medical office buildings, skilled-nursing facilities or life-sciences buildings.
Equity REITs are the opposite of mortgage REITs: They own and manage real estate properties such as apartment buildings, warehouses or office buildings. While mortgage REITs invests in mortgage debt, equity REITs invest in the physical properties themselves. These REITs collect rent from tenants.
Hybrid REITs own both physical real estate and mortgages. These can be a good choice for investors who see the value in investing in both mortgage and equity REITs.
Publicly traded REIT
Publicly traded REITs are registered with the Securities and Exchange Commission and listed on a stock exchange such as the New York Stock Exchange or Nasdaq. You can sell a publicly traded REIT whenever you'd like. You can invest in these REITs through services such as the Schwab U.S. REIT ETF or the Vanguard Real Estate Index Fund. Each of these funds invest in multiple REITs, allowing you to diversify your real estate investments.
Publicly non-traded REIT
While publicly non-traded REITs are registered with the Securities and Exchange Commission, they are not traded on any exchanges. If you invest in one of these REITs, you won’t be able to sell your shares whenever you'd like. You must hold onto your shares until the REITs’ owners list on a public exchange or they liquidate their assets. The SEC says that these events might not occur until more than 10 years after your initial investment. You’ll need to be prepared to hold onto your investment in a non-traded REIT for a long time.
Private REITs are not registered with the SEC and do not trade on public exchanges. Trade association NAREIT says that private REITs can usually be sold only to institutional investors such as large pension funds or accredited investors, individuals with a net worth of at least $1 million.
How Do REITs Work?
According to the SEC, to qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investments. It must also distribute at least 90% of its taxable income to its shareholders each year in the form of dividends.
The SEC also says that a REIT must:
- Be managed by a board of directors or trustees
- Have a minimum of 100 shareholders after its first year of operation
- Have no more than 50% of its shares held by five or fewer individuals during the last half of the tax year
- Invest at least 75% of its total assets in real estate and cash
- Derive at least 75% of its gross income from real estate-related sources such as rents and interest on mortgages
Should You Invest In REITs?
While REITs are a strong investment choice for many, they are not right for everyone. As with all investments, REITs come with both risks and rewards.
Here are some factors to consider before investing your dollars in a REIT.
Benefits Of REIT Investing
Here are some of the most important benefits of investing in REITs:
- More liquidity: You can easily sell your shares in a publicly traded REIT. This makes tit a highly liquid investment, meaning you don’t have to wait for certain events or time frames to access any earnings you might have made.
- Increased diversification: REITs are an easy way to diversify your real estate portfolio of investments. REITs typically invest in several different properties, with many investing in a wide range of assets, including office, multifamily, industrial and retail properties. This allows you to invest in several types of real estate without having to buy these properties on your own.
- Higher returns: REITs don’t pay corporate taxes. This means that they often pay out higher dividend payments. REITs are required to pay out a minimum of 90% of their taxable income to their investors each year. This often results in profitable payouts.
Risks Of REIT Investments
This doesn’t mean that REITs are risk-free:
- Long time frames: It might take several years for the real estate owned by a REIT to increase in value. While you will receive regular dividend payments, you might have to wait years to be able to sell your shares in a REIT for a high profit.
- Expensive fees: Some REITs, especially non-traded REITs, charge costly fees. The SEC says that non-traded REITs might charge upfront fees of as much as 9% or 10%.
- Real estate can lose value: The real estate owned by a REIT isn’t guaranteed to increase in value. It might lose value over time. If this happens, you might have to sell your shares for less than what you paid for them.
How To Invest In REITs
According to the Securities and Exchange Commission, you can invest in a publicly traded REIT by purchasing shares from a broker. That's because these REITs are listed on major stock exchanges.
But what about non-traded REITs? You can purchase these with the help of a broker. Your broker, though, must participate in the non-traded REIT's offering.
Another easy way to invest in a REIT is by purchasing shares in a mutual fund that contains several REITs. You can typically invest in one of these mutual funds online through the fund provider -- such as Vanguard or Fidelity -- or with the help of a broker or a representative from a mutual fund company. You can also invest in REITs through an exchange-traded fund or ETF.
It’s not unusual for investors to have several questions about REITs. Here are answers to some of the most common.
Are REITs a good investment?
Determining if a REIT is a good investment depends on your personal situation and preferences. REITs provide investors with a way to diversify their real estate portfolio while collecting regularly scheduled dividends. And if the value of the real estate in your REIT increases, you might be able to sell your shares for a profit. Be aware, though, that as with all investments, there is no guarantee that the real estate in your REIT will increase in value.
How does a company qualify as a REIT?
To qualify as a REIT, a company must have 75% of its assets and income tied up in real estate and must pay out a minimum of 90% of its profits to shareholders as annual dividends. Companies must meet other requirements set by the SEC.
For instance, a board of directors or trustees must manage a REIT and the company must have a minimum of 100 shareholders after its first year of business. The SEC also requires that REITs have no more than 50% of its shares held by five or fewer individuals during the last half of the tax year. REITs are required, too, to receive at least 75% of their gross income from real estate-related sources such as rents and the interest generated by mortgage loans.
Do REITs pay dividends?
By law, REITs must pay dividends to its shareholders on an annal basis. However, some REITs pay dividends more frequently, sending out payments to shareholders on a monthly or quarterly basis. These regular payments are one reason why many consider REITs such a good investment.
Where can I buy a REIT?
You can buy a publicly traded REIT by purchasing shares in one from a broker. You can also buy shares in a non-traded REIT by working with a broker. For an even easier way to buy into one of these companies, you can invest in a mutual fund that contains REITs.
The Bottom Line
If you are ready to invest in real estate but aren’t ready to buy a building on your own, you might consider investing in a REIT. You can then enjoy the regular dividends that these companies pay out and hope that the real estate in which its invested will increase in value. You can learn how to invest in income-producing real estate by exploring Rocket Mortgage® Learning Center.