Are REITs a Good Investment?

You’ve probably heard the adage that property is one of the best investments you can make. While that’s true, investing in traditional real estate can sometimes be a headache; it’s a long-term commitment that’s dependent on a fluctuating real estate market. It also produces nonliquid investments.

Real estate investment trusts (REITs) offer a hands-off way to benefit from real estate by investing in property that is highly liquid. It sounds nice, but are REITs a good investment?

What Are REITs?

A REIT is a company that owns and operates real estate such as office buildings, apartments and warehouses or real estate debt such as loans and mortgages. REITs are publically traded on stock exchanges, and companies buy real estate or its assets using combined investments from investors. This process allows large and small investors to own shares of large-scale real estate properties. Most REITs focus on a particular property type, but some hold multiple types of properties in their investment portfolios.

Rather than developing properties with the intent to resell, a REIT buys and develops real estate with the intent to lease property space and collect income. REIT companies are required by law to pay at least 90% of their taxable income to shareholders via dividend yield. As a result, shareholders earn a steady income but are required to pay taxes on income.

While the idea of a steady income and owning commercial real estate sounds appealing, REITs can be riskier than other types of investments. Since REITs are limited to real estate and real estate assets, they are highly affected by changes in the real estate market. When interest rates are high, REITs can have negative returns.

Types of REITs

You can invest in REITs individually, through an exchange-traded fund (ETF) or a mutual fund. There are many types of REITs that you can invest in, and an investment firm can guide you to pick the right one for you.

Equity REITs

Equity REITs own or operate income-producing real estate. They are publicly traded and are the most common type of REIT investment. Equity REITs generate revenue from rental incomes and typically invest in retail, residential, industrial or resort properties.

Mortgage REITs (mREITs)

mREITs don’t directly own real estate. Instead, a mREIT provides financing for real estate by lending money to real estate buyers or acquiring mortgages. mREITs are also publicly traded and generate income from the interest earned on mortgage loans.

Public, Nonlisted REITs (PNLRs)

PNLRs are registered with the U.S. Security and Exchange Commission (SEC) but are not traded on major securities exchanges like equity REITs or mREITs. PNLRs also face redemption limitations that can affect their liquidity. Liquidity options are typically limited to share repurchase programs or secondary marketplace transactions. Aside from that, PNLRs work similarly to equity REITs and generate funds from rental incomes.

Private REITs

Private REITs are real estate funds or companies that are exempt from SEC regulation. They don’t trade shares on the national stock exchange and can only be sold by brokers to institutional investors such as large pension funds or to accredited investors. An accredited investor is an individual with a net worth of at least $1 million or with an income of $200,000 or more over the past 2 years. Share redemptions vary by company and can be limited.

Pros of REIT Investing

REITs are a way to add real estate into your investment portfolio without becoming a landlord or having to invest large sums of money in a property yourself. Aside from steady returns, investing in REITs can strengthen your investment portfolio in many ways.

• Higher returns: According to the S&P Index, REITs average a return of about 10%, making them a great way to increase your investment income.
• High liquidity: Publicly traded REITs are liquid, meaning that you can easily sell your shares if needed.
• Diversification of assets: REITs generally don't correlate with the price fluctuations of stocks or bonds and can weather inflation better than other types of stocks, making them less volatile. Since they are less volatile than other stocks, REITs are a good investment choice if you are looking to diversify your portfolio risks.
• High transparency: The market price of publicly traded REITs is readily available and easy to access. You can quickly find current information about your shares’ value and act on it.

Cons of REIT Investing

Though the benefits of REITs are appealing, investing in REITs comes with risks.

• Low growth: Since REITs are required to pay back 90% of their income to shareholders, they offer low capital appreciation. REITs can only use 10% of earned income to reinvest in the enterprise or purchase new holdings.
• Subject to market risk: REITs are affected by downturns in the real estate market and can post negative returns when interest rates are high.
• Low transparency: While publicly traded REITs have high transparency, nontraded REITs don’t always provide timely information about share value. You might not find out how much your share is worth until over a year after your investment.
• Lack of liquidity: Nontraded REITs cannot be easily sold on the open market and there are limitations to share redemptions. It can be difficult to determine the value of your nontraded REIT shares in a timely manner.
• Nontax-advantaged: REIT companies may not pay tax on income, but investors pay taxes on income earned from REIT investments.

Get Real Benefits from Real Estate

Investing in a REIT can enhance your investment portfolio’s stability and earnings if done correctly. When choosing a REIT, make sure you research the company to determine what percentage of its assets are invested in real estate or real estate holdings. A solid REIT holds a range of diverse assets in its portfolio to protect itself against downturns in the real estate market.

While REITs can offer significant long-term benefits and steady income, many financial professionals suggest that REITs make up around 5% of your investment portfolio to protect your earnings from market volatility.

Frequently Asked Questions