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Real estate investing used to be something that was only accessible to a few people – mostly the people who already had excess resources, rather than people who are looking to boost their income. These days, thankfully, real estate investing has gotten much more accessible. It doesn’t take as many resources as it used to if you want to start making money in real estate, and there are more ways to make money in real estate than ever before.
You don’t need to be a realtor, independently wealthy, or even highly informed about local real estate markets to start making money in real estate investing.
REITs, or real estate investment trusts, are a great way to break into the real estate market and start generating extra income, whether you’re an experienced investor or looking to make your very first investment.
The only caveat is, like all investments, you should understand how REITs work, and what to expect from investing in one before you get started.
Let’s talk about what REIT investing is, how REITs work, different kinds of REITs you can choose from, and more.
What Is a REIT?
A real estate investment trust (REIT) [1] is a company that makes money from owning, managing, or investing in producing new real estate properties. Every REIT is a little different and specializes in different kinds of real estate. Some focus on one specific type of real estate, while others have more varied investments.
Typically, investors can invest in a REIT the same way they would invest in other companies or industries, by buying stocks in the REIT. These stocks are traded in mutual funds and on exchange-traded funds (EFTs), and they pay dividends on income produced.
The main advantage of a REIT is that it’s a way to invest in the real estate market, which is often one of the most stable and predictable markets and generally increases in value over time, without having to do the individual research or management that comes with direct property ownership.
How Do REITs Work?
Every REIT is a little different, which is important to remember because you shouldn’t expect the same results from one REIT that you get from another. It’s also important to consider what kinds of investments each REIT makes since that will have a big impact on performance.
At the most basic level, a REIT invests either in existing real estate or in real estate projects, with a specific plan for how to make that real estate profitable. Then, investors are paid a portion of the profits, relative to their level of investment in the fund, after management fees and other costs are paid.
It’s important, when investing in a REIT, to carefully look over the fees and costs associated with the fund. The fewer fees, and the more straightforward the fee structure, the more of the profits you’re likely to receive. Seemingly small fees can quickly add up over time, especially since REITs are designed for long-term investing.
Generally, investors will leave their money in REITs for weeks, months, or years at a time. These trusts are designed to perform well in the long term, rather than generate short-term income. Because investors don’t need to spend a lot of time or energy managing their investments, the main benefits aren’t immediate – unlike other kinds of real estate investment like rental properties or flipping homes, which can both generate faster income.
REITs must meet specific requirements [2], per the legislation that created them in 1960:
- REITs must return a minimum of 90% of their taxable income to investors in the form of shareholder dividends.
- They must invest at least 75% of total assets either in real estate or cash
- They must receive at least 75% of their annual gross income from real estate
- Income can come from many different kinds of real estate transactions, including rent on owned properties, interest on mortgage loans, and real estate sales
- Must maintain a minimum of at least 100 investors, after the first year of the REIT’s existence.
- No more than 50% of the shares in any REIT can be held by 5 or fewer individuals in the last half of each taxable year
Assuming a REIT meets these requirements they don’t have to pay corporate taxes, which allows them to save on real estate transactions and pay more to investors compared with other kinds of investment companies and investment trusts.
That’s a huge advantage because it means that REITs can generally grow faster and pay out larger dividends compared with companies with similar resources in the same amount of time.
Because of the consistent performance in the real estate market, and the unique advantages given to REITs, they are considered an important part of any investment portfolio, not just real estate investors’ portfolios.
Different Kinds Of REITs You Should Know
Like any type of investment, there are more than one type of REIT to choose from. Wise investors should not only include REITs in their investment portfolio but also several different kinds of REITs, to provide a consistent income and performance protection in case other investments don’t perform as well as expected.
Understanding the basics about different kinds of REITs can help you evaluate your investment options and choose the right REIT, or mix of REITs, for your portfolio. Here are 5 types of REITs [3], and the key information you need to know about each:
Retail REITs
Retail REITs focus on retail spaces, like freestanding retail stores, malls, and strip malls. As a result, most storefronts and shopping centers are ultimately owned by REITs. These trusts primarily make their money from rental payments on these retail spaces.
However, there are challenges when it comes to physical retail spaces right now, especially with the internet providing an effective alternative that’s often more convenient for consumers. Well-placed storefronts are still in high demand, as many retailers are struggling to keep their stores open and need to generate more income from existing stores.
It can also be difficult to find new tenants in this kind of stores, which can make income a little more variable. However, large and well-managed retail REITs can offer strong performance, despite these challenges.
Healthcare REITs
Healthcare facilities need physical locations even more than most industries, and they also need relatively specialized, and often large, spaces in order to provide high-quality services. That means that there is a significant amount of healthcare real estate and REITs that specialize in this kind of real estate.
Healthcare real estate can include hospitals, retirement homes, medical centers, and free-standing medical offices, as well as nursing facilities and hospice centers.
REITs charge occupancy rents, and may also receive private pay from renting businesses, or Medicare and Medicaid reimbursements for the use of their real estate.
While this is typically a profitable and in-demand sector, pressure to change the way healthcare is managed in the United States may change that. Especially if the healthcare industry moves to a place where providers are more likely to own the buildings they operate in, instead of renting them.
Mortgage REITs
Mortgage REITs are a little different than the other types. These REITs don’t invest directly in real estate but instead invest in mortgages. The best-known of these REITs are Fanny Mae and Freddie Mac.
Mortgages can be seen as a more reliable and lower-risk alternative to investing directly in real estate, but, as the 2008 crash showed, that’s only as reliable as the quality of the mortgages and the health of the overall economy.
When times are hard, more people and businesses are likely to default on their mortgages, which can pose a serious risk to the profitability of mortgage REITs, more so than REITs with physical properties since loans don’t come with physical assets to back their value.
Mortgage REITs are also vulnerable to increasing interest rates, which can reduce the value of a loan portfolio.
That said, if you can find a good mortgage REIT that is doing well and is well positioned to deal with economic upheavals, they can be a profitable investment.
Office REITs
Office buildings are yet another area REITs can specialize in, renting long-term and short-term office space to businesses of all sizes and types. This can be a profitable and relatively low-cost form of real estate, but it can also be more volatile than other real estate specialties since businesses often downsize and look to save of office space when money is tight.
It’s important if you’re considering an office REIT to understand where they operate, what the economy is like near their main investments, and the understand how local unemployment rates can impact the value of office space.
Residential REITs
Residential REITs own and manage residential properties, typically high-income properties like multi-family apartment buildings and manufactured housing. These trusts tend to concentrate on urban areas, where renting is more common and where there are large pools of people who rent, rather than owning their homes directly.
These REITs depend on a steady supply of new tenants and tend to thrive in areas where there are plenty of jobs and where housing stock is more limited, which pushed people toward renting even when they might prefer other housing solutions.
That means that, when jobs leave an area or the supply of local homes increased, these REITs may be less profitable.
However, with high demand for limited housing inventory being a common feature of many residential housing markets right now, residential REITs have good earning potential for the near future. That said, it’s still important to look at what and where any given REIT is invested, trusts that invested in shrinking areas or that hold a lot of low-demand properties might be less profitable compared with REITs that are more heavily invested in urban and high-demand areas.
Looking For The Right REIT For Your Portfolio?
Investing in REITs sounds a lot easier on the surface than it tends to be in reality. If you want expert assistance choosing the right REIT for your portfolio, or even deciding if investing in a REIT is right for you, Teifke Real Estate can help.
Don’t hesitate to schedule an appointment to learn more about real estate investing, or for professional help with important investment decisions.
Sources:
[1] REIT.com. What’s a REIT (Real Estate Investment Trust)? (n.d.). Retrieved from https://www.reit.com/what-reit on 2023, February 14.
[2] Voigt, K. NerdWallet. (n.d.) Best-Performing REITS: How to Invest in Real Estate Investment Trusts. Retrieved from https://www.nerdwallet.com/article/investing/reit-investing on 2023, February 14.
[3] Ashworth, W. Investopedia. (2022, September 2). 5 Types of REITs and How to Invest in Them. Retrieved from https://www.investopedia.com/articles/mortgages-real-estate/10/real-estate-investment-trust-reit.asp on 2023, February 14.
