REITs (Real Estate Investment Trust)

What are they and why invest?

A real estate investment trust (REIT) is a company that owns, and in most cases operates, income-producing real estate. REITs own many types of commercial real estate, including office and apartment buildings, warehouses, hospitals, shopping centers, hotels and commercial forests. Some REITs engage in financing real estate. More than 87 million Americans actively own shares in various REITs, according to the National Association of Real Estate Investment Trusts.

REITs are a type of investment vehicle through which individual investors can purchase a fractional share of a portfolio of commercial real estate assets, and can be trade on any stock market. REITs can be privately held or publicly traded, and many REITS focus on a particular asset class. For example, some REITs invest mainly in retail properties, while others specialize in office buildings or multifamily apartment buildings.

REITs are a type of investment vehicle through which individual investors can purchase fractional shares of a portfolio of commercial real estate assets. If the REIT is publicly traded, shares can be bought and sold on public exchanges by anyone with a brokerage account.

The US Congress enacted the law providing for REITs in 1960. The law was intended to provide a real estate investment structure similar to that provided by mutual funds for investment in stocks. REITs are strong income vehicles because, to avoid incurring US federal income tax liability, REITs are generally required to pay an amount equal to at least 90 percent of their taxable income in the form of dividends to shareholders.

There are 4 types of REITs:

1. Equity REITs: Most REITs are equity REITs, and they offer an equity ownership stake in a diversified portfolio of commercial real estate properties. In return, investors receive a pro rata share of the cash flow and profits produced by the underlying assets. Most equity REITs specialize in a specific asset class, like shopping centers, data centers, self storage or healthcare facilities.
2. Mortgage REITs: mREITs for short, mortgage REITS provide financing for the purchase of real estate assets. They invest in residential mortgages more frequently than commercial ones, but they can purchase loans for any type of income producing property.
3. Public Non-Listed REITs: Public, non-listed REITS are registered with the securities and exchange commission (SEC) but not traded on public exchanges. They sometimes specialize in specific asset classes, but they do not have a high degree of liquidity because they cannot be bought and sold on public exchanges.
4. Private REITs: Private REITs, or non-traded REITs are exempt from SEC registration requirements as long as they comply with a certain set of rules, most notably they can only sell shares to accredited investors. They do not trade on public exchanges, which means that they are far less liquid than publicly traded REITs.

Most REITs have a straightforward business model: The REIT leases space and collects rents on the properties, then distributes that income as dividends to shareholders. Mortgage REITs don’t own real estate, but finance real estate, instead. These REITs earn income from the interest on their investments.

The risk

Sometimes REITs are miscategorized as “bond substitutes.” REITs are not bonds; they are equities. Like all equities, they carry a measure of risk that is much greater than government bonds. REITs can also produce negative total returns during times when interest rates are high or rising.

There are several ways to invest in commercial real estate, and every investor needs to choose the one that works best for them. In most cases, the easiest and most direct way to invest in a real estate asset is to purchase a property. Direct purchases can yield excellent returns and important tax benefits, but not all real estate investors have the time, expertise, and resources needed to purchase and manage a property. For these investors, fractional ownership of a commercial property may be a compelling option and one of the ways this is accomplished is through the purchase of shares in a Real Estate Investment Trust (REITs)

Advantages of Investing in REITs

Since their inception, REITs have been a popular investment strategy among investors, including individuals and institutional investors, as REIT investors enjoy many benefits such as those listed below.

Low barrier to entry

REITs are available to any investor, large or small, as long as they have a brokerage account and enough cash on hand to purchase at least one share of a REIT on the stock exchange. For retail investors who have limited capital to invest, REITs are a great way to gain exposure to the real estate market and earn a passive investment return over time.

Diversified Portfolio

Investing in any type of REIT at the same time as in other financial instruments will ensure that the investor has a diversified investment portfolio with real estate assets. Even within the REIT asset class, investors may choose to further diversify by purchasing REITs that focus on particular real estate assets, such as retail REITs, office REITs, or healthcare REITs. In this way they can expose themselves to real estate investments that would otherwise be impossible for them.

Return potential

Like other types of real estate investments, REITs have the potential to see capital appreciation over time and generate returns for shareholders. According to Nareit, an industry association, all REITs in the FTSE Nareit REIT Index have had an annual return of 9.09% between 1972 and 2022.

Dividend payments

Under IRS rules in the United States, REITs must pay out at least 90% of their income and earnings in the form of dividends among all their share holders. This means that REITs tend to have high dividend yields compared to other types of stocks.

No corporate tax

As long as REITs follow the rules set forth by the IRS, they can claim special tax treatment, notably, they don’t pay tax at the entity level. Instead, income and profits are passed on to shareholders, where they are taxed at the individual level. This avoids double taxation and helps generate higher returns for shareholders. In addition, the Tax Cuts and Jobs Act of 2017 allows a pass-through deduction of up to 20% on dividends received by investors. This means that investors can deduct 20% of dividend income received from REIT investments.

Passive income

It is important to note that REIT investors can earn passive income from their investment. This means that after making the initial investment, the investor does not need to do anything else to earn a return on their capital. Real estate offers many ways to earn money, but many are time consuming, such as owning and managing rental properties or even shopping malls. REITs eliminate the need for the investor to manage the properties they own, hire property management companies, and deal with contractors, tenants, or leases.

Tangible investments

REITs work well for many investors for the same reason that other real estate investments work well. That is, the underlying assets (real estate) are tangible, which means they are physical assets that can be seen and touched. This is not the case with other types of assets like stocks, or even debt instruments like mortgage-backed securities. Many investors find that they can better withstand short-term market fluctuations knowing that they have tangible investments that have been shown to increase in value over time.

Liquidity

Publicly traded REITs are liquid, meaning they can be bought and sold quickly. This feature provides investors with a high degree of liquidity that is not normally available in other real estate investments, such as direct buying and selling of properties.

Access to Commercial Real Estate

Buying REIT stocks provides investors with fractional ownership in a portfolio of real estate assets, often commercial real estate assets. One of the biggest obstacles for investors interested in commercial real estate is that the asset class requires a large amount of capital to enter. Many commercial properties cost millions of dollars, which the average investor does not have. By investing in a REIT, investors pool their money with others and are entitled to a prorated share of the rental income and capital gains produced by the portfolio.

Disadvantages of Investing in REITs

As with any other investment, there are downsides to investing in REITs. Some of these may be the following.

Dividend taxes

It is important to know that dividends on investment REITs received by investors are taxable income and are subject to income tax. In fact, REIT dividends are taxed as ordinary income. Although REITs have tax benefits associated with dividend income, it is possible for an investor with a very large stake in one or more REITs to incur a truly significant tax bill.

Interest rates

REITs use debt to purchase their assets and work with a broad group of lenders to obtain it. Depending on your debt structure, REIT stock prices can be very sensitive to movements in interest rates, especially when they rise.

High Potential Fees

Investors should note that REITs that are not publicly traded may have high upfront fees or sales commissions, as well as annual management fees, where the management team may take a percentage of the profits in form of payment or promoted interest. All these deductions can reduce the final earnings of the investment.

These are some public REITs that we can find on the stock market

REITs often make good investment returns.

REITs typically pay higher dividends than common stocks. REITs can generate higher returns due in part to the favorable tax structure. These trusts own cash-generating real estate. REITs are typically listed on a national exchange and provide investors with considerable liquidity.

The United States Congress created REITs so that anyone could own income-producing real estate. REITs are required to pay a dividend, making them a great way to earn passive income.

Inflation is making headlines and has become a perceptible part of daily life, with price increases evident in industries related to gas stations, supermarkets and travel, among others. Many companies and their share prices continue to suffer from increases in the cost of raw materials and wages, especially those companies where it is difficult to pass price increases on to end consumers.

REITs, on the other hand, have some real advantages in inflationary environments. As prices rise, property values tend to appreciate, while cash flows generally benefit as well.