Why invest in Real Estate Investment Trusts (REITs)? (2024)

FAQs

Why invest in Real Estate Investment Trusts (REITs)? ›

REITs offer a number of attractive attributes such as growth, income, and diversification. REITs have historically delivered strong results and provide attractive income relative to other asset classes. They offer diversification relative to traditional investments like stocks and bonds.

REITs offer a number of attractive attributes such as growth, income, and diversification. REITs have historically delivered strong results and provide attractive income relative to other asset classes. They offer diversification relative to traditional investments like stocks and bonds.

Performance-wise, REITs offer attractive risk-adjusted returns and stable cash flow. Also, a real estate presence can be good for a portfolio because it provides diversification and dividend-based income—and the dividends are often higher than you can achieve with other investments.

The benefits of a REIT investment include liquidity, diversification, and passive income in the form of high dividends. The potential downsides of a REIT investment include taxes, fees, and market volatility due to interest rate movements or trends in the real estate market.

REITs can be a good choice because: Buying and selling REIT shares is easier than it is with a physical property. They obviate the need for market-specific knowledge and property management while making it easier to diversify your real estate portfolio.

Compared to other investments such as stocks and bonds, REITs are subject to various risk factors that affect the investor's returns. Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.

REITs can provide diversification benefits to an investor's portfolio. Broker-dealers created funds of hedge funds so smaller investors could participate in these types of investments. These funds must be registered under the Investment Company Act of 1940 and usually have a minimum investment amount of $25,000.

Definition: REIT or Real Estate Investment Trust refers to an entity created with the sole purpose of channelling investible funds into operating, owning or financing income-producing real estate.

Investors buy REIT shares and, in turn, receive dividends from investment income or capital gains distributions. REIT shares are traded on exchanges much like the stocks of other companies. This provides relatively high marketability, especially compared to most other types of real estate investments.

REITs engage in real estate activities and can qualify for favorable tax treatment if they pass through at least 90% of their net investment income to their shareholders.

What are the strengths of REIT? ›

REITs allow individual investors to make money on real estate without having to own or manage physical properties. Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making.

Because of their lower volatility, REIT returns are less correlated to the stock market. That makes REITs an excellent way for investors to build a diversified portfolio and improve their risk and return profile.

Private REITs are not traded on an exchange, which means that there are more restriction in who can invest in them. As such, they tend to be less liquid than public REITs since it can be difficult for investors to find buyers for their shares should they decide to sell.

REITs typically invest directly in properties or mortgages. REITs may be categorized as equity, mortgage, or hybrid in nature. Real estate mutual funds are managed funds that invest in REITs, real-estate stocks and indices, or both. REITs tend to be more tax-advantaged and less costly than real estate mutual funds.

Summary of Why Investors May Not Want to Invest in REITs

But, REITs are not risk free. They may have highly variable returns, are sensitive to changes in interest rates, have income tax implications, may not be liquid, and fees can impact total returns.

REITs are often less risky than stocks because they are invested in an appreciating asset versus waiting on the profitability (or not) of a business. Like any investment, though, there are always risks. Just like you could lose money if you invest in a mutual fund or stock, you could also lose money investing in REITs.

REITs historically have delivered competitive total returns, based on high, steady dividend income and long-term capital appreciation. Their comparatively low correlation with other assets also makes them an excellent portfolio diversifier that can help reduce overall portfolio risk and increase returns.

What determines a good REIT? ›

At the individual REIT level, you want to see strong prospects for growth in revenue, such as rental income, related service income, and FFO. You want to see if the REIT has a unique strategy for improving occupancy and raising its rents.

A key difference between investment trusts and funds, is that investment trusts are 'closed-ended', meaning that they have a fixed pool of capital. This makes them easier to manage, as investors buy shares on the stock market rather than by buying them from the fund manager.

They can trust that you will find the best home for them or that you will find their house the best buyer, and you can trust them to listen to your ideas and advice. With trust bridging you and your client, you can expect a smoother process and certain success in their real estate endeavor.

The underlying assets of a Reit are held by a trustee on unitholders' behalf. With Reits, there is a separation of roles be- tween the trustee and the manager. In contrast, a business trust is a hybrid structure combining elements of a compa- ny and a trust.

A real estate investment trust (REIT) gives people the chance to invest in real estate even if they don't have enough cash to buy a property on their own. Residential REITs also give investors the chance to buy into real estate without having to take out a large mortgage loan.

With REITs, it is easier to have a diversified property compared to investing in physical properties. It is more convenient to manage your investments compared to investing in properties. REITs provide better total returns (capital gain + dividends) than property stocks or properties.

REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.

The Cheapest Option: REITs—$1,000 to $25,000 or more

A REIT offers the investor a relatively high dividend as well as a highly liquid method of investing in real estate. Most real estate investments are not easy or quick to get out of. An exchange-traded REIT is. Moreover, you can start small with a little bit of cash.

Disadvantages of REIT Investment

REITs are subject to interest rate risk, which is the risk associated with changes in interest rates. REITs may be subject to liquidity risk, making it difficult for investors to sell their REIT investments quickly.

What are the challenges of REITs? ›

Real estate investments tend to have high transactional costs, especially in legal and brokerage fees. The process of acquiring a new property is also very long and tedious with lots of legal formalities. Another disadvantage of property investments is that they are not easy to liquidate.

However, bonds and REITs are very different, both in terms of their advantages and disadvantages. REITs are a form of equity (stock) that should continue enjoying total returns that are superior to bond returns over time while also doling out higher amounts of current income.

Historically, REITs are one of the better-performing sectors during inflationary periods. We can see this in the following image. You'll notice REITs are in the upper right area, showing they are outperformers during periods of high inflation.

REITs make their money through the mortgages underlying real estate development or on rental incomes once the property is developed. REITs provide shareholders with steady income and, if held long-term, growth that reflects the appreciation of the property it owns.

Perhaps the biggest advantage of buying REIT shares rather than rental properties is simplicity. REIT investing allows for sharing in value appreciation and rental income without being involved in the hassle of actually buying, managing and selling property. Diversification is another benefit.

Are REITs Good Investments? Investing in REITs is a great way to diversify your portfolio outside of traditional stocks and bonds and can be attractive for their strong dividends and long-term capital appreciation.

Pros of investing in REIT stocks

That makes them a favorite among investors looking for a steady stream of income. The most reliable REITs have a track record of paying large and growing dividends for decades.

REITs historically generate strong returns during times of rising rates. Today, REIT leverage is at an all-time low. Maturities are exceptionally long. Inflation results in rapid rent growth and rising replacement cost.

The Cheapest Option: REITs—$1,000 to $25,000 or more

A REIT offers the investor a relatively high dividend as well as a highly liquid method of investing in real estate. Most real estate investments are not easy or quick to get out of. An exchange-traded REIT is. Moreover, you can start small with a little bit of cash.

Why do REITs have to pay 90% of income? ›

By law and IRS regulation, REITs must pay out 90% or more of their taxable profits to shareholders in the form of dividends. REIT investors who receive these dividends are taxed as if they are ordinary income. Plus, whether REITs are public or private, they must pay out the standard 90% of their income.

Summary of Why Investors May Not Want to Invest in REITs

But, REITs are not risk free. They may have highly variable returns, are sensitive to changes in interest rates, have income tax implications, may not be liquid, and fees can impact total returns.

REITs make it possible to invest in real estate without owning physical property. They're a suitable retirement investment for their strong dividends and growth potential. REITs can also offer more portfolio diversification.

Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making. Many REITs are publicly traded on exchanges, so they're easier to buy and sell than traditional real estate.

Bottom Line. REITs are not just more rewarding, they are also a lot safer than rental properties, and especially today. This is ultimately why I decided to end my career in private equity real estate and became a REIT analyst.