All About REITs
Most people are familiar with owning physical real estate and renting or flipping it as a form of investment. They may be attracted to the potential income generation and the relative perceived safety of real estate.
Still, they might not be aware of passive real estate investing. REITs are an alternative real estate investment for those seeking a passive investment opportunity.
Here we’ll share a high level overview of the REIT market.
What is a REIT?
The formal name for REITs is real estate investment trust. REITs are companies that own and operate real estate. Additionally, they may act as financiers of real estate. A REIT is much like a mutual fund, as the capital from numerous investors is pooled to fund the REIT.
REITs are a passive investment in real estate, meaning that the investor does not have to buy or manage any properties to invest in real estate.
Types of REITs
There are quite a few types of REITs that can encompass different forms of property investments and investment strategies. Some of these types include:
Equity REITs make up the majority of REITs and provide diverse portfolios of income-producing real estate. Real estate sectors invested in might be apartment complexes, office buildings, shopping malls, or even a portfolio of rental homes. The REIT might be sector-specific or invested across multiple sectors.
Public non-listed REITs (PNLRS) do not trade on stock exchanges, and so are generally more illiquid, but operate similar to publicly listed REITs.
The liquidity differences from traditional REITs can mean a minimum holding period, and share redemptions vary and are limited. Often liquidity comes in share repurchase programs or transactions in the secondary market. In the past, these REITs have taken different measures to provide liquidity. These measures include selling all or most of their assets, merging, or listing on a national exchange.
REITs go beyond holding real estate for lease or sell. Mortgage REITs (mREITs) are entities engaged in originating or purchasing mortgages and earning interest from the investments. They might also buy or originate mortgage-backed securities.
mREITs are on major exchanges. Their funding sources may include equity, structured financing, and convertible and long-term debt. The goal for an mREIT is to use more equity financing than borrowing to seek increased returns to investors.
Private REITs are not listed on any exchanges and are generally sold only to accredited investors – individuals with net worths of $1 million or more, or with annual income over $200,000.
Pros and Cons of Investing in REITs
Like all things in life, REIT investing has pros and cons..
REITs have some pros that address some of the challenges to buying physical real estate.
Ease of Access
REITs are relatively easy to buy and don’t involve everything that comes with financing traditional real estate purchases. There is no escrow process, and a bank doesn’t need to comb through financial statements and tax returns. A REIT is just like buying shares of a company’s stock, and can be purchased through your brokerage account for most publicly-traded REITs or a broker to purchase non-public REITs.
Buying a property will require some amount of investment for the down payment. If the real estate purchased is $750,000 and requires 10 percent down, $75,000 of liquid capital must be deployed. Additionally, the purchased real estate might need a property manager after closing. For that, one can expect a monthly expenditure or immediate financial investment upfront for repairs or marketing to secure tenants.
On the other hand, REITs are flexible and many publicly-traded REITs have no minimum investment.
REITs can be more liquid than physical investment properties. It can take weeks or months to sell a piece of real estate, depending on the market conditions.
As long as buyers are available, a REIT is saleable anytime. A privately traded REIT can be more difficult to sell.
Your Investment is Passive
Many real estate investors prefer enjoying travel or family activities over dealing with renters or repairs. Late-night calls from tenants are disruptive, and collecting rents isn’t a favorite activity of most anyone. Investing in a REIT requires no active management.
Investment returns from REIT investments are typically realized through quarterly dividend payments, meaning potential for regular cash flow to the investor.
No Outright Real Estate Ownership
Many investors find great contentment from having a physical asset that only they possess. REITs lack personal experience and a sense of ownership. An investor in physical real estate can choose the properties invested in, whereas the REIT investor doesn’t get to make that decision.
Your Vision Doesn’t Matter
Equity ownership of a REIT doesn’t allow you to treat property in accordance with an idea you might have for it. An investor in physical real estate can remodel or upgrade their properties to fit their vision.
No Tax Deductions
Owning properties can mean tax deductions. REITs don’t provide any tax breaks.
Interest Rate Risk
REITs can be subject to interest rate risk, which is when investors move to other investment opportunities in a rising rate environment. That means larger market forces such as the fed funds rate can have a big impact on REIT returns — although real estate is still considered a hedge against inflation.
Loss of Principal
An investor in a REIT could suffer a loss of principal investment if the REIT has a negative holding period return. However, this risk applies to many investment products.
How to Invest in REITs
Publicly Listed REITs
REITs can be purchased through your brokerage account if publicly traded and listed on the major exchanges. Non-listed public REITs will be listed and sold through specific brokers.
Private REITs are comprised of general partners and typically structured as LLCs. They can have rules regarding everything from required minimum investment, to the transference of ownership in the event of the death of a partner.
This post is provided for informational and educational purposes only. It is not intended to be investment advice and should not form the basis of an investment decision.