The Beginner's Guide to Real Estate Investment Trusts

Are you interested in investing in real estate and want to understand what real estate investment trusts (REITs) are? Here is a beginner's guide to REITs to help you better understand them and see if they fit you well.

If you've ever considered investing in real estate but were put off by the idea of managing or maintaining a property, real estate investment trusts (REITs) might be the perfect option for you. REITs allow you to invest in real estate without the hassle of direct property ownership, making it easy to enjoy the benefits of real estate investment.

A REIT is a company that invests in income-generating real estate, such as offices, apartments, or storage facilities. However, it is not limited to these property types; you can also invest in other asset types.

By law, REITs are required to pay out at least 90% of their taxable income to shareholders in the form of dividends, making them a good option for investors looking for a steady income.

There are many benefits to investing in real estate trusts, so if you are interested in real estate investing, keep reading to learn everything you should know about real estate investment trusts.

Here is everything you need to know about real estate investment trusts (REITs).

1. What is a REIT?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-generating real estate. These were created to allow individual investors to invest in large-scale, income-producing real estate.

Through investing in REITs, investors indirectly invest in real estate. REITs sometimes invest in the equity side of commercial real estate, such as apartment buildings, office buildings, and retail real estate. Conversely, investors may opt to invest in the debt side of real estate, acting as the lender for real estate developers or builders, thus helping them finance real estate.

Shareholders receive a percentage of the income the properties generate commensurate with the amount of their investment. To qualify as a real estate investment trust, a company is required to invest 75% or more of its assets in real estate. Furthermore, at least 75% of its gross income must be derived from rent payments, mortgage interest, or selling properties.

2. How Do REITs Work?

Once a fund successfully qualifies as a REIT, investors have the opportunity to purchase shares in various ways. The REIT strategically pools this capital to make investments in different real estate types, including direct ownership of properties, real estate loans, or a combination of both.

Real estate investment trust can be classified in many ways, such as:

1. By the types of investments they pursue
2. By the way in which their shares are traded
3. By the real estate sectors on which they focus

Just like a mutual fund, each share of a REIT represents partial ownership of all the individual assets held by the fund. Any change in the value and price of a REIT's shares directly reflects the change in the value of the overall collection of individual real estate properties the REIT holds.

3. Types of REITs?

There are several types of real estate investment trusts, each focusing on different aspects of the real estate market. These are:

Equity REITs

These REITs directly invest in properties, generating revenue primarily from leasing space and collecting rent on their properties, such as offices, shopping centers, and apartments. Equity REITs are the most common type of REIT and are typically what people think of when they talk about REITs.

Mortgage REITs (mREITs)

Mortgage REITs do not own properties like equity REITs; instead, they invest in real estate loans or mortgages. Their income is derived from the interest on these loans. Due to their operation as lenders, mortgage REITs are particularly sensitive to interest rate changes.

Hybrid REITs

Hybrid REITs combine elements of both equity and mortgage REITs, investing in properties and mortgages to generate income from both rent and interest payments.

4. Pros of REITs

Regular Dividend Income

REITs are highly attractive due to the consistent dividend income they provide. As REITs are mandated to distribute the majority of their taxable income as dividends, they tend to offer superior yields compared to many other stocks.

For income-seeking investors, particularly retirees, REITs represent an enticing avenue to generate steady cash flow without the need to divest their investments.

Diversification

Investing in REITs is an effective way to diversify your investment portfolio by gaining exposure to real estate. Real estate has historically demonstrated a low correlation with stocks and bonds.

This means that real estate may not be affected when the stock market is down. As a result, this diversification can effectively reduce overall portfolio risk and bolster returns.

Professional Management

Another advantage of REITs is the fact that knowledgeable professionals with extensive experience in real estate acquisition, management, and financing oversee them. This provides reassurance to investors, as they are relieved of the burdens associated with property management, including tenant interactions, maintenance, and legal matters.

Therefore, as an investor, you have the opportunity to tap into the expertise of a dedicated team committed to optimizing the value of the properties within the REIT portfolio.

Liquidity

Publicly traded REITs offer the advantage of liquidity, unlike direct real estate investments. Since they are traded on stock exchanges, you can buy or sell REIT shares relatively quickly and easily. This liquidity makes REITs a more flexible investment option, allowing you to make adjustments as needed.

5. Cons of REITs

Just like other things, there are many benefits, but it is also important to be aware of the risks involved as well. Some cons you should understand are:

Market Risk

Like any publicly traded investment, real estate investment trusts are subject to market risk. This means that their value can fluctuate with the stock market, which can be impacted by broader economic conditions, investor sentiment, or even changes in interest rates. 

Sector Specific Risk

It is crucial to remember that different types of REITs can be affected by sector-specific risks. Therefore, it is imperative to consider the specific risk associated with the type of REIT you are investing in because changes can have varying effects on it.

Interest Rate Sensitivity

Changes in interest rates can impact REITs. When interest rates rise, they can increase REITs' borrowing costs, potentially affecting their profitability. Additionally, higher interest rates may make REIT dividends less attractive compared to bond yields, leading to a potential decline in REIT share prices. Investors should consider the influence of interest rate fluctuations on REITs and make informed decisions.

Tax Considerations

When receiving dividends from REITs, it's essential to be mindful of the tax implications. They are usually taxed as regular income, which could result in higher tax rates compared to dividends from other stocks.

It's important to factor this in when evaluating the overall after-tax profits from your REIT investment. Nevertheless, REITs can still offer tax advantages when held in accounts like IRAs.

6. How to Invest in REITs

If you are intersted in adding REITs to your investment portfolio, here are some steps to keep in mind to get started. 

1. Choose the right REIT

Before making any investment, selecting the appropriate REIT that aligns with your investment objectives is essential. It's advisable to begin your research by exploring various types of REITs and analyzing their performance track record. Seek out REITs with a strong history of dividend payments, competent management, and a diverse portfolio consisting of high-quality properties.

2. Buying REITs

You have the opportunity to purchase REITs through a brokerage account, similar to any other stock. Take a moment to consider whether you would like to invest in specific REITs or explore REIT-focused exchange-traded funds (ETFs) or mutual funds, as they provide diversification across multiple REITs. 

3. Building a REIT Portfolio

In order to build a robust REIT portfolio, investing in REITs across different sectors such as healthcare, industrial, retail, and residential is crucial. This will effectively spread out the risk and provide exposure to diverse segments of the real estate market.

7. Are REITs a Good Investment

Real estate investment funds have consistently ranked among the top-performing asset classes. The FTSE NAREIT Equity REIT Index serves as the primary yardstick for evaluating the performance of the U.S. real estate market. As of March 2024, the index boasted a remarkable 10-year average annual return of 6.93%.

Investing in REITs is an excellent strategy for diversifying your portfolio beyond traditional stocks and bonds. REITs can be highly attractive due to their robust dividends and the potential for long-term capital appreciation.

Each type of REIT presents its own set of risks and rewards, which are contingent on the current state of the economy. Engaging in REIT investing through a REIT ETF is an excellent way for shareholders to access this sector without personally grappling with its complexities.

Similar to other investments, REITs have advantages and disadvantages. It's vital to recognize that they are total-return investments, offering high dividend yields and the potential for long-term capital appreciation.

In contrast to traditional real estate, many REITs are traded on stock exchanges, providing diversification without long-term commitments. Liquidity is a critical factor to consider; thus, depending on your objectives, REITs could be an outstanding choice for you.

Methodology

We used information from different sources and our data to create this guide on real estate investment trusts. We combined various data sets to help you learn more about them.

• YieldStreet
• InsiderFinance Wire
• FTSE NAREIT Equity REIT Index
• Investopedia

The following are a few sources we used to gather most of our information about real estate investment trusts (REITs). 

FAQS

How to invest in REITs for beginners?

You can definitely buy shares in a REIT, which is listed on major stock exchanges, just like any other public stock. Additionally, investors can purchase shares in a REIT mutual fund or exchange-traded fund (ETF).

How much money do you need to start a REIT?

You can get started without needing a huge amount of money. The cost of entry is simply the share price of the trust that interests you. Do keep in mind that private REITs are exclusively available to accredited investors and have minimum investments starting in the low thousands.

What is the public with real estate investment trusts?

Real estate investment trusts are traded on major stock exchanges and are subject to price movements in financial markets. It is crucial to understand that investors may receive less than their original investment if they decide to sell their shares on the public exchange.

The Beginner's Guide to Real Estate Investment Trusts - The Bottom Line

Investing in real estate through Real Estate Investment Trusts (REITs) offers a beautiful opportunity to build your investment portfolio. It's a unique and accessible way to benefit from income generation, diversification, and professional management without the complexities of owning physical property.

While it's important to consider the risks, the potential rewards can truly enhance your investment portfolio. Whether you're looking for a steady income, hoping to diversify your investments, or aiming to gain exposure to the real estate market, REITs can be an excellent choice for investors at any level.

Understanding how REITs work, their benefits, and what to be mindful of allows you to make well-informed decisions that align with your financial goals. Making these decisions about investing can be significant in your life, and having the right knowledge can make it easier and more satisfying.

If you are considering moving or selling, contact us or visit our website. Our team at Raleigh Realty is here to help you with any home buying or selling needs.