REITs are a type of investment that own and operate income-producing real estate. In the United States, REITs are required to pay out at least 90% of their taxable income as dividends.
REITs (Real Estate Investment Trusts) are investments that invest in real estate. They can be a good way to diversify your portfolio and they often have low or no fees.
REITs, or real estate investment trusts, have been in existence for more than 60 years. They were created when President Dwight D. Eisenhower signed Public Law 86-779, which enabled investors to engage in income-producing real estate projects that were sold as investable securities.
This was the beginning of a $3.5 trillion sector that has expanded to include a broad variety of specialized vehicles that invest in various types of assets, such as residential single and multi-family apartments and/or large-scale health care facilities.
REITs are a popular choice among investors who like hard assets, and they may provide a layer of diversity to the traditional stock/bond portfolio recommended by financial advisers.
If you’re interested in learning more about REITs, including how they operate, how they’ve fared over time, and how you may invest in them, the following article covers all of that and more.
What Are Real Estate Investment Trusts (REITs)?
A real estate investment trust (REIT) is a mechanism for investors to engage in major projects involving the development, purchase, or management of a collection of real estate assets.
The majority of REITs are publicly listed, which means that investors may buy a piece of the company that owns the properties on a conventional stock market. Non-listed and private REITs, on the other hand, are additional kinds of REITs.
To be classified as a REIT, the holding company must have a long-term investment strategy, distribute at least 90 percent of its taxable income to investors, and invest at least 75 percent of its assets in real estate.
However, other REITs, such as mortgage REITs, offer funding for real estate developments in the form of loans or by originating or dealing with mortgage-backed securities, which are the main assets they would keep on their balance sheet rather than real estate buildings.
Pro Tip: Not all REITs are made equal; some invest directly in buildings, earning rental revenue and management fees, while others invest in real estate debt, earning interest and management fees (i.e. mortgages and mortgage-backed securities).
How Do Real Estate Investment Trusts Work?
Investors may get exposure to REITs by purchasing shares in any of the hundreds of vehicles that are presently available on the open market. Each share represents a part of the REIT’s equity and gives the common shareholder the ability to vote on a variety of matters affecting the business.
Investors benefit from REITs in two ways. They generate cash profits in the form of dividend payments, as well as capital gains in the form of stock price rises.
REITs do not pay corporate taxes, avoiding the double-taxation problem that investors often face when receiving dividends from the companies they control.
REIT Investing Options
The majority of REITs are publicly listed corporations with shares that can be purchased and sold on conventional stock markets. However, not all REITs are made equal, so in the following part, we’ll go through the many kinds of REITs you’ll come across so you can choose the ones that best suit your investing strategy.
REITs (Real Estate Investment Trusts)
An equity REIT is perhaps the most prevalent kind of REIT on the market. These firms invest in a broad variety of income-producing assets, but they prefer to specialize on a particular sector or market niche depending on the management team’s experience and the possibilities that arise.
Lodging and resorts, healthcare, services, retail, industrial, residential, office, data centers, and other sectors are examples of REITs. See the table below for further information.
Aside from specific sectors, some REITs, known as diversified REITs, possess a diverse portfolio of properties in a variety of industries. Due to their widely diversified structure, these REITs are intended to survive sector-specific downturns, but their returns may be lower than those generated by specialist REITs, since losses from one failing area may pull the trust’s total performance down.
The Investors part of each REIT’s official website typically has a summary of the trust’s strategy, performance, and portfolio, and the REIT’s annual reports, also known as 10-K filings, usually include a more in-depth examination of these and other issues.
REITs that invest in mortgages
Mortgage REITs, or mREITs for short, provide a variety of services to real estate developers, purchasers, and other REITs. They may offer fee-based services, provide finance to any of these parties, or originate and deal with mortgage-backed securities (MBS).
To qualify as a mortgage REIT, a firm must invest at least three-quarters of its assets in real estate-related securities, have 100 or more shareholders, and pay out at least 90% of its taxable revenue in dividends to investors.
Mortgage REITs, like other REITs, are not subject to corporation taxes.
REITs with a hybrid structure
In essence, a hybrid REIT is a combination of the two kinds of REITs described above: equity REITs and mortgage REITs. A hybrid REIT’s aim is to boost investor returns by merging these two operations into a single company while lowering the risk associated with pure-play mREITs.
The main accounts on a hybrid REIT’s balance sheet will be split between fixed assets, which are the REIT’s properties that it owns and operates, and investable securities, which in this instance are mortgage-backed securities and other real estate-related financial instruments.
Because mortgage REITs are notoriously hazardous owing to their susceptibility to interest rate fluctuations, hybrid REITs seek to mitigate that risk by investing a part of their portfolio in income-producing properties that are more stable.
REITs that are publicly traded
The majority of REITs are publicly listed companies with shares that can be purchased and sold on a conventional stock market. The Securities and Exchange Commission (SEC) of the United States regulates these trusts in the same way that corporations are.
Buying and selling shares of a publicly listed REIT is the same as buying and selling shares of Coca-Cola (KO) or PepsiCo (PEP), and most brokerage companies now charge zero fees for these transactions.
Publicly listed REITs are required to disclose their financial statements on a quarterly and annual basis in the form of 10-Q and 10-K reports, as well as to notify investors of significant business events in the form of 8-K filings.
Non-listed REITs that are open to the public
Retail investors may invest in public non-listed REITs, although their shares are not traded on conventional exchanges. Instead, licensed brokers or networks provide them to enhance their liquidity.
Fundrise, DiversyFund, and CrowdStreet are a few of these sites. These REITs must also register with the Securities and Exchange Commission (SEC), publish financial reports on a regular basis, and disclose important business events. Non-listed REITs must also publish their net asset value (NAV) on a regular basis to keep investors informed about the value of their assets.
Liquidity is the primary distinction between publicly traded and publicly non-listed REITs. When dealing with these securities, however, additional brokerage costs apply, as well as a higher minimum investment requirement.
REITs that are privately held
Private REITs are entities through which sophisticated investors, usually institutional investors, may get access to real estate possibilities provided by well-known industry participants.
The instruments provided by these REITs are not required to be registered with the Securities and Exchange Commission, and only accredited investors are permitted to buy shares of these trusts. An accredited investor is someone who fulfills certain requirements, such as having a net worth of at least $1 million or an annual income of at least $200,000 for individuals and $300,000 for married couples.
Private REIT shares are not listed on public exchanges, and trading costs are often greater than for the other two kinds of REITs. They are also less liquid than their regulated counterparts owing to the lower number of potential investors who are accessible and willing to purchase the assets at any one moment.
Private REITs are not obliged to report their results on a regular basis, and corporate governance rules are typically set by the trust’s Board of Directors.
How to Examine a Real Estate Investment Trust
Despite the fact that REITs operate similarly to traditional corporations, specific financial measures and ratios aid in better presenting the underlying performance, financial health, and profitability of this kind of business.
Here’s a rundown of the key indicators to look for when examining a REIT’s financials:
Funds from Operations (FFO): The FFO measure attempts to modify a REIT’s net earnings by excluding any non-relevant non-cash costs such depreciation of the trust’s assets. The FFO is a more accurate indicator of a REIT’s profitability since these assets do not always lose value to the degree indicated by depreciation costs throughout the period the REIT owns them.
Due to the distortion created by excessively high depreciation charges, the payout ratio of a REIT should be calculated using FFO rather than GAAP net profits. The greater the payout ratio, the more of the REIT’s earnings will be distributed to shareholders in the form of cash dividends.
There is also an alternative measure known as Alternative FFO (AFFO), which incorporates adjustments for charges that the trust’s management may consider non-recurring or exceptional to the point where they may be distorting the trust’s underlying profits.
Debt-to-EBITDA (D/EBITDA): The Debt/EBITDA ratio is used to determine how indebted a REIT is in relation to its operational earnings. In most instances, the smaller the ratio, the better. However, as long as the firm’s operational earnings substantially surpass the amount paid in interest and the debt-to-asset ratio stays conservative based on the mark-to-market valuation of the trust’s assets, a healthy level of leverage is generally good for REITs.
Interest Coverage Ratio: A REIT’s interest coverage ratio is calculated by dividing its yearly FFO by the amount of interest paid each year. The greater the ratio, the better, since it shows that the trust has adequate money to fulfill its financial commitments’ interest share.
A REIT’s net asset value (NAV) is determined by subtracting the value of all of its assets from the value of all of its liabilities. The outcome is regarded as the REIT’s shareholder equity.
The book value of both components of the formula is used to determine the NAV in principle. However, a more realistic assessment of the NAV would utilize the mark-to-market price of the trust’s assets rather than their book value, since the outcome may be very different if market circumstances change or the property prices fluctuate significantly over time.
Dividend Yield: A REIT’s dividend yield indicates how much money an investor will get for every $100 invested in the company. A 3% dividend yield, for example, would result in a $3 yearly dividend paid to the investor in cash. Although a high dividend yield is generally seen as positive, a high percentage indicates that the market has doubts about the trust’s ability to keep the payout at its present level in the future.
A credit rating is given to a REIT based on its financial health, performance in the past, and future prospects. Companies like Fitch Ratings and Moody’s estimate and give these ratings, and the top REITs have A+ ratings, which indicate their ability to fulfill their financial obligations as anticipated.
Understanding REIT Taxes
Despite the fact that REITs are organized similarly to corporations, they are taxed differently as a result of their unique status. They are a mechanism through which ordinary investors may profit from the real estate market’s progress.
REIT profits are not taxed at the corporate level, which means that no matter how much the trust makes, only the investor is responsible for the taxes incurred.
Dividend payouts will be taxed as ordinary income, and capital gains will be taxed at the same rate if sold less than a year after they were acquired. If they are kept for more than a year, though, they may be taxed at a reduced rate — the long-term capital gains rate.
By keeping REIT dividends and capital gains in tax-deferred accounts such as individual retirement accounts (IRAs) and Roth IRAs, investors may postpone paying taxes on their REIT income and capital gains.
The Advantages of Investing in REITs
- By include an asset class that is directly exposed to a distinct market, portfolio diversity is increased.
- By bypassing the double-taxation system that applies to conventional company dividends, tax savings are passed on to shareholders.
- Depending on the investor’s interests and area of expertise, there are a variety of REITs to select from.
- When opposed to businesses that depend largely on intangibles to create profits, REITs invest in physical assets, and valuing them is typically simpler.
- REITs have historically provided excellent returns while exhibiting less volatility than the stock market.
- In the form of dividends and price growth in the trust’s assets, these investment vehicles offer a mix of fixed and variable income.
- Because shares of publicly listed REITs may be readily exchanged on conventional stock exchanges, they provide a high degree of liquidity to investors.
REITs are obliged to pay out 90% of their taxable income to their shareholders.
The Drawbacks of REIT Investing
- Certain REITs are very susceptible to economic cycles, and their value may plummet during downturns.
- The value of a REIT’s portfolio requires a thorough understanding of the local real estate market in which the properties are located.
How to Invest in REITs: Frequently Asked Questions
These are some of the most common questions we receive regarding REITs from our readers.
Why Should I Invest in Real Estate Investment Trusts (REITs)?
REITs are an excellent complement to a conventional stock and bond portfolio since they provide investors with an additional layer of diversity as well as a source of fixed income. Furthermore, since dividends are not taxed at the corporate level, a larger percentage of REIT earnings wind up in the hands of investors.
Dividends from REITs are taxed differently.
Dividends paid by REITs are solely subject to individual taxation. This implies that only the shareholder will pay taxes on the trust’s profits, not the trust itself. These dividends are considered regular income and are taxed as such.
To invest in REITs, how much money do you need?
The price of a share of publicly listed REITs is the lowest amount that may be invested. However, several brokers now provide the option of purchasing fractional shares, allowing investors to purchase a portion of a REIT’s stock rather than a full unit.
Non-traded REITs, on the other hand, usually need a minimum investment of $1,000 and may go considerably higher depending on the scale and magnitude of the project. Finally, owing to the complex nature of private REITs, the minimum investment may start at $10,000 or greater.
Are Real Estate Investment Trusts (REITs) a Good Investment?
According to statistics from Nareit, REITs outperformed US stocks by approximately 3% between January 1990 and October 2020, while their standard deviation — a measure of volatility — was also lower, at 6% against 13.8 percent for US shares.
Although historical comparisons may be skewed based on the precise start and end dates of the study, it is apparent that REITs would add favorably to a portfolio’s returns since they are less volatile than stocks.
How Do You Profit From a REIT?
REITs allow you to profit from the trust’s periodic dividends, which are paid in cash to the trust’s stockholders. You may potentially profit from the REIT’s stock price growth.
For non-listed and private REITs, on the other hand, this price appreciation is usually reflected in the REIT’s NAV.
Are REITs a Good Inflation Hedging Strategy?
Investors often purchase hard assets to hedge their net worth against inflationary pressures, thus the price of real estate assets tends to increase when inflation rises. Furthermore, since rent payments may be modified depending on market circumstances, the income-producing aspect of real estate holdings is advantageous from an inflation perspective.
As a result, REIT dividends will often rise during periods of greater inflation, but the degree to which they exceed the market’s overall prices would likely differ from one REIT to the next.
Last Thoughts
REITs are an intriguing investment instrument that may help investors diversify their portfolios by include a well-known asset type – real estate.
Furthermore, the wide universe of accessible REITs makes this sector attractive to individuals with a thorough understanding of the real estate ecosystem’s dynamics. If they can discover possibly discounted REITs, investors may profit from calculating the underlying value of REITs.
We hope that this advice was sufficient in preparing you to begin investing in these appealing products.
Up Next
REITs are a type of investment that allows investors to buy shares in real estate companies. This is a great way for beginners to invest because it can be done with very little money and there is no risk involved. Reference: reit investing for beginners.
Frequently Asked Questions
How much money do you need to invest in REITs?
REITs are a type of investment that is similar to stocks. The price of REITs fluctuates in the market and you can buy or sell them at any time. As with all investments, it is important to understand what you are investing in and how much risk you are willing to take on.
How do I start a REIT investment?
REIT stands for Real Estate Investment Trust. Its a type of investment that is made in order to buy shares of a company that owns and manages properties such as office buildings, shopping malls, hotels, etc.
Are REITs good investments?
REITs are a type of investment that is traded on the stock market. They are commonly known as real estate investment trusts.
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