A real estate investment trust (REIT) is a type of investment often considered in an equity or fixed-income portfolio. For those looking for better diversification, this type of investment option can be a very good choice. Let’s look a bit closer at what a real estate investment trust is and how it works.
What is a Real Estate Investment Trust?
According to investor.gov, REITs “allow individuals to invest in large-scale, income-producing real estate. A REIT is a company that owns and typically operates income-producing real estate or related assets. These may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans.”
REITs don’t develop real estate properties to have them sold, however. They buy and develop properties as a part of an investment portfolio.
For individual investors, a real estate investment trust provides a way to earn income from a shared commercial real estate project. You won’t actually have to go out and buy a commercial property to invest in real estate with a REIT.
5 Types of REITs to Consider
1. Mortgage REITs
About 10% of all REITs are found in mortgages instead of real estate. Fannie Mae and Freddie Mack are two of the most well-known mortgage REITs. Both are government-sponsored enterprises and they both will buy mortgages on the secondary market.
While it might seem less risky to invest in a mortgage REIT, they still come with risk. If interest rates go up, they could cause the mortgage REIT book values to go down.
2. Residential REITs
Some REITs will buy and operate multi-family rental buildings, such as apartment buildings or manufactured housing communities. It’s important to consider many factors before you make this type of investment.
It’s common for apartment markets to be very good in areas where home affordability is low compared to the rest of the country. Larger cities might offer good opportunities.
3. Healthcare REITs
As Americans age and healthcare becomes more expensive, healthcare REITS might become more popular. These include investments in nursing facilities, retirement homes, medical centers, and hospitals. The success of this type of investment will have a lot to do with the healthcare system and its’ success.
When looking at a healthcare REIT, you will likely want to look at the diversification of the customers. It’s a good idea to spread out your risk with different types of companies in this space.
4. Retail REITs
Nearly one-quarter of REIT investments are in freestanding retail or shopping malls. It’s the biggest type of investment found in America. In fact, there’s a high chance that the shopping center you go to regularly is owned by a REIT.
A retail REIT will make money from the rent paid by tenants. If there is a cash flow problem for tenants, it can cause defaults or even bankruptcy. If this happens, the REIT has to find a new tenant to replace the old tenant.
It’s best if you plan to invest in retail REITs that you choose those with strong anchor tenants. These tenants may include home improvement stores or grocery stores.
Before investing in any retail REIT, you want to look at the industry and the REIT itself. It’s important to understand the type of investment you’re getting into. In a down economy, a retail RETI may provide opportunities that good companies will take advantage of.
5. Office REITs
It’s a pretty straightforward type of REIT. Office REITs will invest in office buildings and make their money from rental income. They usually have tenants with long-term leases.
It’s important to look at the vacancy rates, the unemployment rate, the area where the REIT invests, and the amount of capital for acquisitions with this type of REIT.
Common Things to Look for in a REIT Before Investing
There are several things you want to look for in a REIT before you invest. Some of the most common things to look for include:
- Dividend Yield – REITs may often be compared to dividend stocks. When rental income is collected, the income is spread across the investors as a dividend. If you’re investing to generate income, you want to look at the dividend yield of the REIT first.
- Balance Sheet – Of course, you want to look at the balance sheet to see the funds available for repairing, managing, acquiring, and renting real estate. It’s important to make sure the REIT you choose can cover the costs and generate a return.
- Occupation Rates – While the occupation rate doesn’t matter with some REITs, it’s important with others. You may want to look at the occupation rates when choosing a REIT.
- Valuation – It’s possible for an REIT to be undervalued or overvalued. It may also trade at a fair market value. It’s important to look at the valuation before you make your decision.
- Diversification – You will want to diversify your portfolio. This means you may want to choose REITs that offer diversification. For example, if you invest in a residential REIT, you may want one that has properties in more than just one market. Then, if one market crashes, the others can help provide a positive return to cover losses.
- Funds from Operations (FFO) – You want to look at this metric to figure out how much money is generated through the operation of the fund.
It’s often smart to have a professional help you when investing in REITs. Make sure you know what you’re getting into before you choose to invest your money.
Pros & Cons of Real Estate Investment Trusts
All investments come with pros and cons and real estate investment trusts are no different. You want to understand the pros and cons before you invest in any type of REIT.
Pros
- Very liquid
- Provides portfolio diversification
- High-yield dividends
Cons
- Sensitive to changes in interest rates
- Dividends will be taxed as ordinary income
- Some properties come with high risk
A Few Popular REITs
There are many REITs out there, but there are a few that are a bit more well-known than others. Some of the most popular real estate investment trusts include:
- Prologis (NYSE: PLD)
- American Tower (NYSE: AMT)
- Equinix (NASDAQ: EQIX)
- AmeriCold Realty Trust (NYSE: COLD)
- Crown Castle International (NYSE: CCI)
- Physicians Realty Trust (NYSE: DOC)
- CubeSmart (NYSE: CUBE)
- Digital Realty Trust (NYSE: DLR)
- STORE Capital (NYSE: STOR)
- Innovative Industrial Properties (NYSE: IIPR)
There are many REITs out there. These tend to be some of the most popular options for investors to consider.
Frequently Asked Questions About REITs
Is a REIT a good investment?
This question has to be answered on a case-by-case basis. However, REITs are known as a good way to diversify your portfolio when combined with traditional stocks and bonds. They can be very attractive due to the dividends.
Is it possible to lose money in a REIT?
Yes, you can lose money with any investment. Publicly traded REITs come with a risk of losing value if interest rates rise. Make sure you understand the risk before investing in a real estate investment trust.
Is a REIT a safe investment during a recession?
Some REITs may be rather safe during a recession, while others may not. Each type will be a bit different and each individual REIT can also be different. Make sure you look into the investment you plan to make to answer this investment question.
Which type of REIT should I invest in?
REITs come in a variety of types with different risks and benefits. It’s important to assess your current portfolio and your risk tolerance before you choose the right REIT for you. You might want to invest in REITs with a REIT ETF. This can help you to invest without all the complexities of the sector.
How will I make money from investing in a REIT?
REITs are required by the IRS to pay 90% of their taxable income to the shareholders. This is done through a REIT dividend, which is often higher than the average stock dividend. You can earn a passive income from investing in the right REITs through high-yield dividends.
What are the historical returns of REITs?
The historical returns of real estate investment trusts are some of the top options for investors. The average return in the U.S. market from 2010 to 2020 is about 9.5%
The three-year average between November 2017 and November 2020 was a bit higher at 11.25%. This is above the S&P 500 and the Russel 2000, which were both under 10%. Most investors looking for yield will do better in real estate investing compared to fixed income investing.
When you’re considering making an investment, you might want to look closely at real estate investment trusts. This type of investment can offer the right choice for some investors. It’s a way to invest in real estate without needing to find and buy a property yourself.
Make sure you do your research and it can help to find an investment adviser you trust. With the right adviser or broker, you can make the best investments for your portfolio.
Jordan Fabel
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