A real estate investment trust, or REIT (pronounced “reet”), can be a great addition to any long-term investment portfolio. REITs have the potential to produce impressive returns over time when property values rise. When Primior guides their investors to diversify their portfolio, REITs are one avenue for excellent income generation. Investors can choose REITs that specialize in various types of properties, such as apartments, offices, retails and more. With that in mind, here’s an overview of REITs that all investors should know about before their first purchase.
What is a REIT?
REITs are investment vehicles where investors pool money together to buy real estate assets. REITs are similar to an exchange-traded fund, or ETF, except instead of investing in stocks or bonds, REITs uses investors’ money to acquire properties. Once you purchase shares in a REIT, you are a partial owner of those properties. REITs earn income from their properties or other real estate assets and pass that income onto investors in the form of dividends. REITs are traded on major stock exchanges, but some REITs are privately held.
To qualify as a REIT, a company must comply with certain provisions provided by Congress in the Internal Revenue Code. These include requirements for long term ownership of income-generating real estate, and distributing income to shareholders:
- It must be an entity taxable as a corporation, managed by a board of directors or trustees.
- It must have at least 100 shareholders, with no fewer than five holding 50 percent of shares
- It must invest at least 75% of its assets in real estate, cash or U.S. Treasuries
- It must derive at least 75% of gross income from rents on real estate, interest on mortgages financing real property or from sales of real estate.
- It must pay out a minimum of 90% of its taxable income to shareholders in the form of shareholder dividends each year
- 95% of income is to be passive, such as rental payments, which don’t require direct action from the corporation.
Equity versus Mortgage REITs
There are two broad categories of REITs – equity and mortgage. Equity REITs are the most common and public traded REITs, which means that they own physical properties for the purpose of generating income. Properties such as apartments, office suites, malls, medical facilities, other concentrated commercial rental properties are typically acquired in Equity REITs. Generally, these REITs have reasonable returns at acceptable risk levels. Mortgage REITs invest in mortgages, mortgage-backed securities, and other mortgage-related assets. Generally, there is a higher risk in a mortgage REIT due to interest rate fluctuations. This results in trading mortgage REITs to be more of a shorter term strategy than equity REITs.
You may find other hybrid REITs that operate using the investment strategies of both equity and mortgage REITs. Private REITs are new in the real estate investment scene and generally offer higher dividends, but they lack liquidity and carry a higher sale commission to the seller. These REITs aren’t registered with the SEC and don’t trade on national securities exchanges.
Pros and Cons of Investing in REITs
REITs can be an important part of your investment portfolio. They are as liquid as stocks, and there are plenty of opportunities to diversify. They provide stable cash flow and offer attractive risk-adjusted returns. The SEC regulates REITs, and even requires audited financial reports to be generated. However, only 10% of taxable income can be reinvested, as they pay 90% of income back to investors. Dividends are also taxed as regular income, and you may be outweighed by the market risk and high fees.
How to Invest in REITs
You can invest in publicly traded REITs, REIT mutual funds and REIT ETFs by purchasing shares through your broker. For a non-traded REIT, you can purchase shares through a broker or financial advisor who participates in the non-traded REIT’s offering.
Many REITs are included in an increasing amount of defined-benefit and defined-contribution investment plans. Factors to keep in mind for a REIT are the REIT’s management team and track record, as well as their compensation method. You can also gauge a REITs anticipated growth in earnings per share and current dividend yields. For REITs that hold a performance-based compensation, they’ll tie in the best strategies to pick the right properties for their investors.
Through REITs, you can take advantage in the long run of increasing returns with a broad investment vehicle. Partners like Primior understand that investing in real estate is one of the smartest financial decisions you can make, and they know how to skillfully navigate the complex market can help investors deliver real value that appreciates over time. Primior is one of the fastest growing real estate investments firms in California and helps investors make informed decisions every step of the way.