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Real estate is a powerful tool for building long-term wealth, but there are barriers to entry. Perhaps you’ve thought about investing in property but feel priced out of the market or intimidated by the responsibilities of being a landlord. Real estate investment trusts (REITs) offer an excellent solution. They offer a way to invest without buying physical property, letting you get a piece of the real estate pie without having to buy the whole tin.
A REIT is a mutual fund, but for real estate. Instead of buying a share of multiple stocks, you’re buying a share of multiple properties.
A real estate investment trust company owns and manages a portfolio of income-producing properties, such as office towers, shopping centers and apartment buildings. They collect rent from tenants, then distribute most of that income to the shareholders — including you, if you invest in them. REITs come in different categories:
The returns can vary significantly year to year based on the economy and interest rates, so pinpointing an average is tricky. To calculate the total return, you need two components — the dividends you receive and any increase or decrease in the REIT’s stock price.
Over long periods, the total returns of REITs have often been competitive with broader stock market indexes. While some years see very high returns, others can be flat or negative, especially during economic downturns or periods of rising interest rates.
The benefits of investing in a real estate investment trust include the following.
Diversification is not putting all your eggs in one basket, which helps manage risk when investing. Adding REITs to a traditional portfolio of stocks and bonds will give you exposure to the real estate market, which often behaves differently from its stock counterpart.
REITs have the potential for consistent income. To qualify for tax benefits, they must pay at least 90% of their taxable profits as dividends.
For example, if a real estate investment trust earns $10 million in taxable profit, it must pay out at least $9 million to its shareholders. This structure is what makes REITs’ yields often higher than those of typical stocks.
Compared to buying a physical property, investing in REITs has lower barriers to entry. For example, you can buy a single share of a rental for a relatively small price, versus needing a large down payment for a house. You get a share of the profits while the REIT handles the rental income and management.
If you need to access your money, you can sell your shares on any day the stock market is open. That’s impossible with a physical property, which can take months to sell.
Here are some of the disadvantages of REIT investments.
When interest rates rise, new and safer investments like government bonds start offering more attractive yields. Competition can make REIT dividends seem less special, causing investors to sell their shares and lower their prices.
Real estate investment trusts also often use loans to buy new properties. When interest rates go up, their debt becomes more expensive, which can eat into profits and, consequently, dividends.
Most stock dividends are “qualified” and taxed at a lower capital gains rate. REIT payouts are usually “non-qualified” and are taxed at your regular income tax rate, which is typically higher. For example, if you’re in the 22% tax bracket, you’ll pay 22% on your REIT returns. Compare that with how you might only need to pay 15% on qualified dividends from another stock.
Beginners must beware of the risks of non-traded REITs. These often come with high up-front fees — around 9%-10% of the investment — that immediately reduce the value of your asset. Unlike a stock, you can’t easily sell a non-traded REIT. You might have to wait years or sell at a steep discount, so your money is effectively locked up.
Assess your investment goals and preferences. REITS might be a good fit for you if you’re an income-focused investor, aiming to generate a steady stream of passive income. They’re also one of the best entry points for beginners who want exposure to the real estate market without the hassle of being a landlord.
If market volatility makes you hesitant, be aware that REIT stock prices can fluctuate like any other stock. A diversified REIT ETF — a single investment, traded like a stock, that holds a diverse basket of different REIT companies — might be a better choice than individual real estate investment trusts.
If you’ve decided on investing in REITs, these steps can help get you started.
A brokerage account is an investment account used to buy and sell securities. Opening one usually only takes a few minutes and requires basic personal information, including your social security number.
Compare the different ways to invest in REITs and choose which to prioritize:
For individual REITs, review their property portfolio, dividend history and management team. For ETFs, check their expense ratio or the annual fee and the index it tracks.
REITs lower the barrier to real estate investing, offering unique income, liquidity and diversification opportunities. They provide lucrative benefits, but also come with market and interest rate risks that you must be mindful of. Don’t rush when entering this arena. Continue your education, assess your financial situation and start small as you build confidence. With the right know-how, the benefits of real estate investing are within your reach.
