Imagine being able to invest in the lucrative world of real estate just like you would in the stock market, but without the hassle of actually buying property.
That’s the simplicity and beauty of REITs, or Real Estate Investment Trusts. Created in 1960, REITs open the door for everyone to earn from commercial real estate. At its core, a REIT is a company that owns, operates, or finances income-generating real estate. By investing in a REIT, you can earn income from real estate ventures without the need to own physical properties yourself. REITs combine the benefits of real estate with stocks. This tutorial covers everything about REIT real estate investment.
REITs have more than 535,000 properties and total real estate assets of approximately $4.5 trillion. The market value of publicly traded REITs increased to $1.75 trillion in 2021, a yearly growth of 17.6%. In 2021, REITs supported over 3 million employment and distributed $92.3 billion in dividends.
Table of Contents
What is a REIT (Real Estate Investment Trust)?
REITs manage or finance assets that generate income and real estate. They hold a portfolio of assets like mutual funds and ETFs. Investors buy REIT shares and get a piece of asset income. By modifying the Cigar Excise Tax Extension in 1960, Congress authorized investors to purchase shares in a commercial real estate portfolio, resulting in REITs. Since then, REITs have expanded to hold $3.5 trillion in US assets, according to NAREIT.
REITs attract investors who wish to invest in real estate without owning it. They’re also popular due to their distinctive taxation. REIT variations are only taxed by investors, unlike most stock dividends, which are taxed twice. A REIT is a pass-through corporation that distributes all its revenue to investors or owners; thus, it pays no corporate tax. This boosts investment returns.
How Do REITs Work?
In 1960, Congress amended the Cigar Excise Tax Extension to create REITs. The provision lets investors acquire commercial real estate portfolio shares, formerly accessible exclusively to rich people and major financial intermediaries.
REIT portfolios may comprise apartment complexes, healthcare facilities, data centers, hotels, office buildings, retail centers, infrastructure (cell towers, fiber cables, energy pipelines), timberland, self-storage, and warehouses.
REITs often focus on one real estate industry. Diversified and specialized REITs may own office and retail buildings. Many REITs are openly listed on major financial exchanges so that investors may trade them like REIT stocks (for example, $PLD, $WELL and $AMT to name a few). REITs trade heavily and are liquid.
For instance, imagine earning a share of the profits from a bustling shopping mall (ie: $SPG)or a state-of-the-art office building, all without having to buy the mall or office yourself. That’s the opportunity REITs offer to investors.
How Do REITs Make Money?
The REIT pays its stockholders dividends after leasing space and collecting rent from the properties. Mortgage REITs finance real estate rather than owning it. The interest on these assets provides revenue for these REITs.
The Internal Revenue Code requires REITs to meet certain requirements. These conditions include long-term ownership of income-generating real assets and shareholder distribution. (IRS) “Instructions regarding Form 1120-REIT (2021)“
REIT companies must satisfy these criteria:
- Invest a minimum of 75% of total assets in cash, US Treasury bonds, or real estate.
- Make at least 75% of your revenue from rentals, mortgage interest, or real estate sales.
- Annually distribute 90% of taxable profits as shareholder dividends.
- Be a corporation-taxable entity.
- Be run by trustees or directors.
- At least 100 stockholders after its first year
- Hold 50% of its shares by five or fewer people.
The mortgages that support real estate development provide revenue for REITs, as do rental payments from developed properties. If kept for a long time, REITs provide shareholders growth that corresponds with the value of the real estate they own in addition to a consistent income stream.
What Kind of Returns Do REITs Provide to Investors?
Property appreciation, rental revenue, and market circumstances affect REIT returns. Investors might earn recurring income from REIT dividends and capital gains from stock market sales.
- Dividend and Interest Payouts: REITs distribute Net Rental Income as dividends and interest. After deducting administration and maintenance costs, a REIT earns money by renting and leasing commercial real estate. Management fees, depreciation, maintenance, etc., are subtracted from Gross Rental Income to get REIT Net Income. SEBI requires REITs to distribute at least 90% of total rental revenue as dividends and interest for investors.
- Capital Gains: REITs are traded on stock markets; thus, their prices fluctuate with performance and demand. Like stocks and mutual funds, REITs perform well, raising their unit prices, which investors may sell for a profit and earn Capital Gains. Next, let’s examine the pros and cons of investing in REIT units.
Is It Possible to Lose Money on a REIT?
Losses are possible with any investment. Publicly listed REITs risk losing value if interest rates increase and investors shift to bonds.
What if a REIT Doesn’t Pay Dividends?
A REIT’s GAAP results may first seem to show that it has not generated any revenue and is not required to pay a dividend. Even yet, some REITs continue to distribute dividends while having negative GAAP profitability.
Well Let’s hear Jim Cramer out:
What Risks Do REITs Present?
REITs are vulnerable to many of the same hazards as the general real estate market, such as variations in property value, lease occupancy, and regional demand. Interest rate fluctuations may have a significant impact on real estate prices and demand for tenancy.
What Types of REITs Are There?
There are various REIT types. First, let’s categorize REITs according to access:
Equity REITs
Real estate investment trusts (REITs) that generate income are mostly equity REITs. Rent is the main source of revenue—not the sale of assets.
Mortgage REITs
Mortgage REITs provide direct loans and mortgages to real estate operators and owners, or they might do it indirectly by purchasing mortgage-backed securities. The difference between what they are paid in interest on mortgage loans and what it costs to finance such loans is their net interest margin, which is what essentially drives their profits. They may be more susceptible to rises in interest rates as a result of this model.
Hybrid REITs
These fall somewhere in between mortgage and equity REITs. Hybrid REITs often use a portion of the accumulated capital to purchase real estate, with the other portion going toward lending money to developers in the form of mortgages.
Publicly-traded REITs
REITs that are publicly listed are traded on prominent stock exchanges, such as the Nasdaq and the New York Stock Exchange (NYSE). A publicly listed REIT is accessible to investors with a brokerage account. The SEC requires public REITs to register and publish audited financial reports. Currently, public REITs have $2.5 trillion in assets, while U.S. REITs possess over $4 trillion in gross real estate.
Non-traded public REITs
All investors may invest in public non-traded REITs, although they are not listed on stock exchanges. Investors may buy online portals, commonly referred to as real estate crowdfunding platforms, or public non-traded REITs via their financial adviser. In addition to registering with the SEC, publicly listed non-traded REITs are required to provide audited financial data.
Private REITs
Non-traded private REITs are not open to the general public. Usually, only those with high net worth or high incomes are eligible. The SEC does not require private, non-traded REITs to register.
What Are REIT Requirements?
REITs offer shares that may be purchased and sold like regular equities on the stock market. At least 75% of the company’s assets must be invested in real estate, and at least 75% of its income must come from real estate-related operations for it to be classified as a REIT.
What Are the Pros and Cons of REITs?
There are multiple benefits to investing in REITs, including the following:
- Dividend Yields – This is the biggest benefits of REITs given the 90% rule (see below). Their dividend yields are often higher than those of other equities, which makes them the perfect choice for anyone looking to generate passive income from real estate.
- Diversification – Because REITs are often less volatile than other equities, they provide diversification from the stock market.
- Tax Benefits – Because REITs are exempt from federal corporate income tax, investors are protected from “double taxation.
- Returns – They provide attractive potential total returns, such as dividend income and stock price growth.
- Liquidity – When it comes to liquidity, publicly listed REITs are superior to pure real estate ownership. This benefit makes it stand out in other types of Real Estate Investments.
- Transparency – Public REITs provide audited financial statements and are known for their high level of transparency.
- Cost Efficiency – Less expensive than outright purchasing commercial real estate.
REITs do, however, have some disadvantages, such as:
- Tax Liabilities – Increased tax liabilities due to nonqualified dividend payments made by REITs. For this reason, it’s recommended to own REITs in an IRA or other tax-advantaged account.
- Interest Rates – Sensitivity to variations in interest rates. The price of REIT stock often drops as interest rates rise.
- Real Estate Specific Overhead – Hazards unique to a certain property, such as digital change, industry headwinds, and tenant move-outs.
- Debt – The risks of using excessive debt.
How to Make REIT Investments?
Investment in REITs can be made in lots of ways.
Publicly Traded REITs
Most people need to think about these REITs because they are the most prevalent. The Securities Exchange Commission (SEC) oversees these REITs, and their normal minimum investment is minimal.
Non-traded public REITs
Also referred to as non-listed REITs, these businesses are subject to regulations and reporting obligations set out by the SEC while not being traded on a national stock market and having particular investment limitations. Inventors are required to buy shares straight from the REIT or an independent broker.
Compared to public REITs, non-listed REITs are much less liquid and may have longer time horizons. They could also have hefty transaction costs upfront.
Private REITs
SEC registration is not necessary for private REITs. As such, they come with a larger risk and are usually intended for institutional or accredited investors. They also usually have a significantly higher minimum investment amount, generally in the five-figure level.
REIT Funds
Almost every asset type has an exchange-traded fund (ETF) or mutual fund linked to it, REITs included. These vehicles, which are managed funds offered by investing firms such as Fidelity and Vanguard, allocate the bulk of their assets to real estate investment trust (REIT) shares and associated derivatives.
A REIT fund can make sense if you want the greatest amount of diversification or don’t want to investigate individual REITs.
What is the REIT 90% rule?
SEC Investor Bulletin:
A business needs the majority of its assets and revenue to be related to real estate investment in order to be eligible as a REIT. It must pay out dividends to shareholders each year in an amount equal to at least 90% of its taxable revenue.
Real Estate Investment Trusts (REITs)
Getting Started with REITs
Before taking the plunge, it’s wise to discuss your plans with a financial advisor to ensure REITs align with your overall investment strategy.
- Research different types of REITs to find one that matches your investment goals.
- Consider how much you want to invest and what kind of returns you’re looking for.
- Open a brokerage account if you don’t already have one, as this is where you’ll buy and sell REIT shares.
- Start small and gradually increase your investment as you become more comfortable.
Consider the example of a Northeastern U.S. healthcare system that diversified its real estate portfolio through REITs. By focusing on underrepresented sectors like healthcare facilities, they achieved a more balanced and resilient investment strategy.
LaSalle Securities: Case Study of Successful REIT investments
Here’s an interesting case study from LaSalle Securities shows how adding REITs to a present real estate portfolio may significantly alter the portfolio’s sector makeup. The customer is a $4 – 5 billion U.S. healthcare system located in the Northeast, with a real assets allocation of 3.0–5.5% (including real estate).
The customer of LaSalle Securities had investments in many private real estate funds with significant exposure to retail and office space. LaSalle Securities received a complaint from the customer about the funds’ performance and their lack of exposure to speciality real estate or the new economy.
Together, the client and the LaSalle Securities team mapped out their current real estate portfolio allocation, found the gaps, and then developed a unique universe of REITs to fill those gaps. Then, using this unique universe, the LaSalle Securities team “completed” the client’s portfolio.
Some key take-aways from the Case Study that highlights the uniqueness of REIT investment:
- Unique Diversification – REITs unlock unparalleled portfolio diversification, marrying the resilience of real estate with the agility of stock investments.
- Direct Access to Specialty Markets – REITs grant direct entry into booming real estate sectors like tech and healthcare, minus the direct ownership hassles.
- Enhanced Liquidity and Professional Management – Trading REITs is as straightforward as stocks, but with the bonus of expert management navigating the complex real estate market for you.
- Personalized Portfolio Strategy – Tailor your investments with REITs for a portfolio that’s as individualized as your financial aspirations, blending strategy with personal touch.
Conclusion
Dive headfirst into the dynamic world of REITs and unlock the door to smart, strategic real estate investment without the traditional barriers. Ready for more on real estate investment? Our beginner’s guide awaits to deepen your understanding, or join our upcoming webinar to connect with experts and fellow investors.
Happy Real Estate Investing!
