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How to Invest in a Real Estate Investment Trust (REIT)

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Wondering how to invest in real estate without the hassle of buying and managing properties? Getting started can be difficult, but real estate investment trusts (REITs) let you do just that. REITs are companies that earn money by owning income-producing real estate. Investors who own shares of the company receive a share of the income by earning dividends.

What is a REIT?

A real estate investment trust (REIT) is a company that allows you to invest in income-producing real estate. A REIT either owns or provides financing for real estate assets, such as residential homes, shopping centers, office buildings, hotels or self-storage units. In general, REITs don’t develop properties to resell them. Instead, they earn money by buying properties and renting them out as part of an investment portfolio.

Investing in REITs gives individual investors the opportunity to invest in commercial real estate without having to buy it themselves. REITs distribute at least 90% of their taxable income as dividends paid to investors, according to the U.S. Securities and Exchange Commission (SEC).

How do REITs work?

The National Association of Real Estate Investment Trusts (NAREIT) estimates that REITs own $3 trillion in assets. REITs get their initial capital from individual investors who buy shares of the company. Using investor money and (occasionally) outside bank financing, a REIT buys income-producing properties like office buildings and rents them out.

Owning a share of REIT stock is a hands-off form of real estate investing. Investors who own shares of a REIT do not directly own the real estate owned by the company, and they aren’t involved in the day-to-day operation of the REIT. Investors earn profits without managing a portfolio of investment properties.

How to invest in a REIT

REITs can be either non-traded or publicly traded. To invest in a publicly traded REIT, you buy shares of the REIT through a stockbroker, including online brokers, just like you’d buy shares of a stock or a mutual fund.

Non-traded REITs are sold through specific financial advisors authorized to sell shares of the company. Upfront fees for buying non-traded REITs average between 9%-10%, according to the SEC.

Types of REITs to invest in

  • Mortgage REITs. Mortgage REITs primarily issue loans for real estate or buy mortgage-backed securities. These REITs earn interest income when borrowers repay their mortgages.
  • Equity REITs. Equity REITs are the most common type of REIT. These REITs own income-producing properties and make a profit (after paying overhead expenses) from renting the properties out or when they sell. The REITs distribute the income to shareholders as dividends. Equity REITs have different strategies, such as holding different types of real estate (i.e. office buildings, apartment complexes or shopping centers) or focusing on specific geographic areas.
  • Hybrid REITs. Hybrid REITs invest in issuing mortgages and in owning income-producing real estate. It is important to gain a clear understanding of the hybrid REITs investing strategy to determine if it’s a fit for your portfolio.
  • Lifecycle REITs. Lifecycle REITs are a type of equity REIT where fund managers raise capital for two to three years. Funds are locked up in the REIT for a period of time before the managers seek a liquidity event, such as listing the portfolio on a stock exchange.
  • Net asset value (NAV) REITs. A NAV REIT model is where the fund has perpetual offerings and liquidity events, and the model is gaining popularity. Thomas Hlohinec, a financial advisor with experience developing REIT products for pension funds explained that NAV REITs may offer opportunities for investors to sell shares as often as once a month. These REITs try to grow their total value (assets less debt owed) perpetually instead of relying on liquidity events.

What are the best REIT stocks?

REIT stocks are simply the shares of a REIT that an investor can buy or sell. There are hundreds of REITs that are publicly traded and more that are non-traded. With so many options, it can be tough to decide which REIT stock is best for you. Consider these factors:

  • The historic dividend yield. Many people who invest in REITs want to earn passive income. On average, REITs have a dividend yield of 4%.
  • Correlation with stocks. “Most people investing in REITs are trying to earn returns independent of the stock market,” said Jovan Johnson, an accountant and Certified Financial Planner in Atlanta. If you want to diversify your investments, ask a financial advisor to explain whether the movements of a REIT stock correlate to stock market movements.
  • Investing strategy. Most REITs are equity REITs. However, other REITs have investing strategies that include buying debt or issuing loans.
  • Investing fees. Non-traded REITs have fees that average 9%-10% of total investments, but fees can climb as high as 15% of investments.

Pros and cons of investing in a REIT

Pros Cons
Gain exposure to large-scale real estate Funds may be locked up in a non-traded REIT for a long time
Don’t have to finance investment properties or manage real estate on your own Dividends from REITs are taxed as ordinary income, not dividends
Provide diversity from investing in stocks and bonds Diversification can be limited

FAQs about real estate investment trusts

How do REITs make money?
Most REITs make money by buying large-scale real estate and earning rental income from it or, eventually, selling the properties. Some REITs make money by issuing loans.

How do I join a real estate investment trust?
Investors can buy shares of publicly traded REITs through a stockbroker. If you’re interested in a non-traded REIT, work directly with a financial advisor who’s authorized to sell REIT shares.

Do REITs trade in the secondary market?
Investors can easily buy and sell publicly traded REITs through a typical brokerage. However, non-traded REITs are more difficult to sell or liquidate. It’s up to the REIT manager to determine when investors in a non-traded REIT will get their money back. Sometimes, investors must wait eight or more years before getting a return of capital. If a non-traded REIT does allow you to resell shares, you may be required to sell at a significant discount.

What are the tax implications of investing in REITs?
REIT dividends are taxed as ordinary income, which means they could be taxed at a higher rate than other dividends. However, most REIT income qualifies for a 20% deduction because the IRS classifies it as a special form of business income. “[From a tax perspective], it’s a really good time to invest in REITs right now, but think about your overall goals with the investment first,” Johnson told LendingTree.

How do I choose a REIT?
REITs can provide an excellent investment, but they should be just one part of your overall investment portfolio. To avoid putting too much of your nest egg into a single investment, talk to a fiduciary financial advisor who can offer advice on your overall investment strategy.

 

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