What is a REIT? A Comprehensive Guide

Real estate has long been known as one of the best places to invest your money. But let’s face it, not everyone has the time or the desire to deal with buying and managing rental properties. What if  there was a simpler way to invest in real estate?

The good news is that you can always get your foot in the door by adding Real Estate Investment Trusts (REITs) to your investment portfolio. When you invest in a REIT, you’re essentially buying shares in a company that owns or operates income-generating real estate. These investment vehicles, like a stock or an ETF, allow you to get a share of the company’s income.

According to Nareit, the National Association of REITs, nearly 150 million Americans own REITS, or 45% of the population. So what makes them unique? Let’s break down what REITs are, the different types, and the pros and cons you need to know before investing. 

What is a REIT and How Does it Work?

The U.S. Securities and Exchange Commission defines REITS as companies that own and operate income-producing real estate and related assets. This means these companies pool together money from investors to buy properties. These properties can range from apartments to shopping complexes and even warehouses. 

A Real Estate Investment Trust, also called a REIT, is a company that owns, operates, or finances real estate properties that make money. These companies, in return, give shareholders a portion of their earned income through dividends and total returns. According to the SEC, companies qualify as REITs if they distribute at least 90 percent of their taxable income yearly to shareholders.

Everyone from a newbie investor to a retiree can take part in REITS, whether that’s directly purchasing them yourself on the stock market or indirectly through a fund such as your 401(k).

When were REITs Created?

The U.S. Congress created the first REIT in 1960 through the REIT Act. Congress wanted investors of all backgrounds an equal opportunity to invest in “large-scale, diversified portfolios of income-producing real estate.” But now, investors all across the globe flock to REITs as they have the potential for steady dividend income.

How is a REIT Different from Other Corporations?

REITs operate under a unique structure that sets them apart from traditional corporations. There’s a lengthy list of requirements these companies need to satisfy in addition to the 90 percent taxable income rule mentioned above. One example is that these companies must have a board of directors or trustees who manage them. The companies need at least 100 shareholders after the first year they classify as REITs, and nearly three-quarters of their total assets must be real estate and cash.

If you think that’s all to keep a company accountable, there are even more stringent requirements. The one that stands out amongst them all and puts the “real estate” in REITs is that 75 percent of the company’s gross income must be from real estate.

What Types of REITs Can You Invest In?

There are many different types of REITs you can invest in, depending on what you’re familiar with. The most common types you may hear in financial circles are equity REITs, mortgage REITs, and hybrid REITS. Each has different strategies and risk profiles that draw in investors based on their preferences and goals. 

Equity REITs are companies that will own income-generating properties such as commercial offices, shopping centers, and others. Equity REITs bring in revenue from rental income and property appreciation. 

Mortgage REITs, on the other hand, are companies that invest in mortgages and mortgage-backed securities, which are investments similar to bonds. The revenue of these companies comes from interest in these vehicles. 

Hybrid REITs are a mixture of both Equity REITs and mortgage REITs. They own physical properties that produce rental income and invest in real estate securities. 

It’s important to note that it can be publicly traded and offered through a private redemption program. 

What are The Benefits of Investing in a REIT?

There’s no shortage of benefits to investing in a REIT.

  • Diversification for Less Risk:  REITs expose investors to diverse real estate assets, reducing overall portfolio risk and volatility. Similar to how a mutual fund has a distributed risk factor since it’s a pool of many different types of stocks, so is a REIT regarding real estate.
  • High Dividend Yields: The U.S. Congress mandates that REITs distribute at least 90 percent of their taxable income through dividends. This feature makes REITs attractive to new and old investors alike. 
  • Can Buy and Sell Easily: Since many REITs are traded on major stock exchanges, you can buy and sell them quickly during business hours. 
  • Well Managed: By investing in a REIT, investors benefit from professional management, reducing the burden of property management responsibilities.
  • Returns Can Increase: Property values increase over time, so REITs may experience capital appreciation, enhancing overall returns.

What are the Risks Associated with REITs?

Like the flip side of a coin, several risks are associated with investing in REITs. There are only so many, if any, investments without risk. 

For starters, REITs are sensitive to interest rate changes. Interest rates set by the Federal Reserve can shift borrowing costs. Therefore, REITs can lose money. Since REITs often depend on investor money to create their funds, if investor sentiment changes, then this could impact how much the shareholder will receive that year. But even outside investor sentiment, if you look at broader macroeconomic factors such as interest rates, inflation, and the real estate market cycle, these can all shift the performance of REITs. 

Also, there’s a human element to consider as well. Fund managers aren’t fortune tellers. The quality of a REIT’s success may stem from the management team’s decisions. Also, different sectors of real estate pose additional risks. Lastly, government changes in tax laws and regulations around REITs can also impact what shareholders receive. 

How Can I Reduce My Risk with REITs?

Like any investment, you should analyze the risk factors using a professional’s help. An advisor can walk you through how a REIT’s historical performance, niche, portfolio quality, dividend yields, financial ratios, and the broader macroeconomic environment will affect your success. The right advisor will work in a fiduciary capacity, which means they always seek your best interests. 

Both REITs and direct real estate investments come with risks. Buying a REIT on a stock exchange can give you peace of mind for specific reasons, such as their diversification and how easily you can buy and sell them. However, purchasing your real estate property gives you more control at the expense of higher risks. 

People focused on their financial future and retirement outlook at REITs due to their ability to generate consistent dividends. An investment vehicle’s diversification factor, ability to withstand risk, and how easily it can be bought and sold make it an excellent option for retirement. 

What Should I Know About Taxes and REITs?

Like any other investment, there are tax implications if you purchase a share of REITs. Anytime you sell a security or gain dividends, you must count it as part of your yearly income. Dividends from REITs are no exception. 

Ensure you also check your state laws to see how to treat your REIT dividend income. To avoid paying taxes upfront, you can invest in an IRA or 401(k)s. These vehicles take your pre-tax dollars and support them. A Roth IRA, on the other hand, consists of post-tax income. Therefore, you won’t be penalized as long as your money has been there for five years. 

What Does the Future of REITs Look Like?

You may be an early retiree looking at your investment choices for your golden years or a newbie investor with a newfound interest in the market. Either way, REITs will continue to play a pivotal role in your portfolio. Their edge against traditional stocks makes them enticing in the long run for anyone who desires reliability and diversification in their portfolio. 

  • Bullish Investor Sentiment: One key reason investors remain bullish towards REITs is that even in the most challenging economic times, such as the COVID-19 pandemic, these investment vehicles managed to recover. Anytime the economy sours then bounces back, demand for real estate increases. When demand for real estate increases, investor appetite for REITs grows. 
  • A Central Asset Class:  Real estate is one of our basic human needs. Everyone needs shelter, workspace, and infrastructure to run our economy. Even though our economy ebbs and flows, humans will always desire real estate. REITs will remain relevant as our population grows and businesses want to expand. More people will mean building more commercial and residential properties. Those who own these properties can generate steady income for their shareholders through dividends.
  • Constant Evolution: As technology continues to advance and companies have to build new structures to accommodate these changes, REITs will remain relevant. REITs can invest in these new data centers, logistics facilities, and healthcare properties and in turn, give everyday investors a cut of the pie. 
  • Online Business Will Propel Growth: E-commerce has driven demand for logistics and fulfillment centers. The e-commerce market was valued at $13.4 billion last year and is expected to grow at a compound growth rate of 12% through 2030. REITs focusing on industrial properties stand to benefit from the increasing need for last-mile delivery solutions.
  • Rise of Technology: Many real estate companies are taking part in the AI revolution. With these technological advances, there will be positive shifts in tenant experience. 
  • ESG Investing Will Bolster Growth: Environmental, social, and governance (ESG) will sentiments by the public will help REITs that prioritize sustainability and adopt green practices.
  • International Investors: More and more countries are adopting the U.S. REIT model. Nearly 40 countries have REITs. 
  • Tax Incentives: Investors can deduct 20 percent of their taxable business income if they own REITs. 
  • Inflation Shield: Property values and rents tend to rise along with inflation. Therefore, REITs make an attractive option to protect your disposable income and assets. 

REITs are an investment option for both seasoned and newbie investors alike. Even if you don’t want to purchase your rental property, you can get access to the market through REITs. To navigate this investment vehicle’s intricacies and whether or not it would be a great choice for you, you should consult with a financial advisor or professional. From shifts in technology to macroeconomic factors, your REIT performance depends on various factors. Consider remaining up-to-date on the latest news and developments. 

By strategically integrating REITs into their portfolios with the help of Arabella Capital, investors can harness the potential of real estate to achieve their financial goals and secure their financial future.

The content provided on our platform is intended for informational purposes only and should not be considered personalized financial advice. Any investment decision should be based on your financial goals, risk tolerance, and circumstances. Past performance does not indicate future results, and investing in financial markets carries inherent risks. We do not guarantee the accuracy or completeness of the information presented, and we recommend consulting with a qualified financial advisor before making any investment decisions. Our firm disclaims any liability for financial losses incurred from the use of our platform or reliance on the provided information.

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