Real estate investment is a great way to produce long-term, reliable wealth. But for those without substantial capital, investing in commercial real estate the traditional way could be out of financial reach. However, there is a way for investors in all tax brackets to get a piece of the CRE pie. Real estate investment trusts, or REITs, allow investors to purchase a share of a property and receive dividends based on their investment. But what is a REIT, and how can you benefit from investing in one? Here, we’re exploring the real estate investment trust and how you start earning money in the commercial real estate sector.
Want more information about REITs or other CRE investments? Talk to your financial advisor or connect with one of our real estate pros.
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What is a REIT?
The real estate investment trust (REIT) is a company or corporation that owns and often operates income-generating commercial properties. Like other CRE investors, REITs can own property in any sector – multifamily, office, medical, industrial, or others. Unlike traditional CRE investors, however, REITs allow multiple investors to own shares of the property. Therefore, every investor receives dividends accordingly.
These investment trusts have been popular with investors since their introduction in the 1960s. To protect investors, REITs must meet Internal Revenue Service guidelines that protect against fraud. The IRS guidelines include provisions on profit distribution, number of shareholders, and approved holdings for the REIT.
The essence of a REIT is simple: a corporation owns properties, mortgages, or securities. Individual investors buy shares of a REIT. The corporation leases and manages the property. All the investor has to do is sit back and collect a portion of the profits from that rental income.
REITs allow the average investor to own a piece of commercial real estate. Moreover, they’re a reasonably liquid holding and are a valuable part of a diversified investment portfolio.
Types of REITs
Just as with traditional real estate investments, REITs cover a wide range of properties and types. What is a REIT and how can you invest? There are two main REIT categories: Equity and Mortgage.
Equity REITs
Equity REITs hold tangible properties and rent those properties to tenants. As a result, investors receive dividends based on rent payments on those properties, minus operating costs. These REITs could encompass any type of real property:
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Retail
What is a REIT that proves historically profitable? Nearly a quarter of all REITs are in retail real estate. REITs often own shopping centers, malls, and freestanding retail properties. And while certain retail locations have predictably steady returns – like grocery stores or home improvement retailers – others represent much riskier investments. During the economic recession in 2008, many REIT-purchased retail properties suffered. REITs lost 40% of their value during the housing crisis.
However, as the economy rebounded and retail centers began to see increased growth, REITs once again proved profitable. In the first three quarters of 2019 alone, shopping centers saw a 25% return.
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Residential
Residential REIT investing typically includes apartment buildings or other multifamily housing complexes. REITs see the best returns in markets where housing affordability is low. In these markets, multifamily complexes are almost always at capacity, leading to higher profits for REITs and their investors. Residential REITs are typically a less risky investment because housing is always a necessity.
However, it’s essential to assess the supply and demand in the area where the REIT owns and operates its housing investment. The most significant returns come from regions where single-family homes are unaffordable for many, where rents are steady, and where vacancy rates are lowest.
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Healthcare
Healthcare REITs are becoming increasingly popular as Americans age. REITs invest in senior housing facilities, hospitals, outpatient medical centers, and nursing homes, among others. Thanks to an aging population and an increase in those covered by Medicaid and Medicare under the Affordable Care Act (ACA), healthcare REITs are booming. More and more urgent care clinics, medical offices, and assisted care facilities are popping up all over the country. However, some investors are wary that changes to the ACA could negatively impact healthcare REIT profits.
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Office
Office REITs purchase professional space and often lease to long-term tenants. Currently, with unemployment rates at historic lows, office space proves to be a profitable investment. These buildings see low vacancy rates and low turnover.
Even in a slow economy, large business hubs like Washington, D.C., New York, and Los Angeles still see high returns on REITs. For that reason, office REITs remain popular with investors.
Mortgage REITs
Where an equity REIT purchases real property, a mortgage REIT purchases debts. In other words, the REIT purchases mortgages or mortgage-backed securities on the secondary market. Then, the REIT and its investors earn profits from the interest paid on those holdings. The REIT does not own or manage the property and does not make money from tenant rents. Instead, investors receive dividends based on the interest paid on the property mortgage.
Some 10% of all REITs are invested in mortgages.
Hybrid REITs
Hybrid REITs hold a combination of both actual property and mortgages. These portfolios typically declare an investing focus, leaning more heavily on either real estate or mortgage acquisitions.
Why Consider REIT Investing?
A real estate investment trust is an easy way to diversify your portfolio and invest in commercial real estate without providing millions of dollars in capital. These investment trusts allow everyday investors to receive dividends from a variety of properties nationwide.
But why should you consider investing in a real estate investment trust?
Historic Returns
If you’re still wondering “what is a REIT and is it good for my portfolio?” just look at history.
Historically, real estate has proven to be one of the most reliable investments. Even when the stock market takes a dive, real estate remains relatively steady. That’s why so many investors use real estate as a long-term investment strategy.
However, unlike direct real estate investing, REITs are liquid, allowing you to buy and sell quickly. Each share is packaged for easy trading, meaning you can sell off your share if the property is underperforming. If you owned an underperforming asset outright, you’d be stuck trying to liquidate the property, making mortgage payments and paying closing costs along the way.
But investors who buy into a REIT get the benefits of real estate investing without the hassle. What is a REIT? It’s an investment that does all the heavy lifting – purchasing property, identifying tenants, and managing the property – while your only job is to cash the dividend check. And REITs allow you to invest in multiple properties across multiple property types as well.
Even casual investors can make tremendous returns with REITs.
How to Invest in a Real Estate Investment Trust
REIT investing is easy. You can purchase publicly-traded and non-traded REITs through a broker or financial advisor. However, not all REITs are created equal, so do your homework and ensure the product you purchase is the best fit for your portfolio. Contact a reputable financial planner for more information about investing in REITs.
Potential Risks and Benefits
As with all investments, there are potential risks with REITs. Real estate investments are always subject to fluctuations in the real estate market, and REITs reflect those fluctuations. Other factors like unemployment rates, interest rates, and local economic growth also play a part in REIT success.
Risks
- Some REITs have a lower overall rate of return compared to stock market investments.
- Rising unemployment rates or rising interest rates could affect investor dividends.
- No tax advantages or tax deferments as offered by traditional real estate investing.
- Subject to high management and transaction fees.
- Not properly understanding what is a REIT, and choosing the wrong product for your portfolio.
Benefits
- An easy way for newcomers to invest in real estate.
- Low minimums mean those with little capital can still invest.
- Investment portfolio diversification.
- No property management, tenant applications, or real estate purchase fees.
- Liquidity means investors can buy and sell shares quickly, unlike with real estate ownership.
- Steady, long-term returns.
- REITs often outperform other investment types, especially with a downturn in the stock market.
REIT Property Management
If you manage a non-traded REIT and need a professional company to manage your properties, our expert real estate property management team would be honored to partner with you. Please contact one of our team members to learn more about non-traded REIT management with Lumicre.