Real estate investment trusts (REITs) have historically offered some of the best returns for long term investors, even over stocks.
So why are they kept a secret? Why are they not in more investment portfolios?
Today’s guide will teach you all the basic fundamentals of REIT investing.
By the end, you’ll have gained a significant amount of knowledge about REITs, and know whether or not they are right for your portfolio.
Let’s dive in.
What is a REIT?
REIT (pronounced REET, rhymes with street) stands for real estate investment trust.
You can think of a REIT as a mutual fund that only invests in real estate. Even more specifically, you can think of a REIT as an ETF.
That’s because, like ETFs, most REITs are publicly traded on the stock market. This makes investing in REITs accessible for anyone who has a brokerage account.
A real estate investment trust (REIT), from a technical standpoint, is a company that owns income-producing real estate.
A single REIT can own hundreds of real estate properties, including office buildings, apartments, retail strips, hotels, and even cell towers.
How do REITs work
When you purchase a REIT, you are actually purchasing a share of stock from the company that created the REIT. However, you do not have any ownership over the physical real estate that the company owns.
Still, as with any publicly traded company, you own part of the company when you own stock in the company.
As a part-owner, you’ll receive ownership benefits such as dividend payments.
REITs are required by Federal law to pay out at least 90% of its profits to shareholders (you) annually.
And it’s not uncommon for some REITs to payout 100% of its profits to shareholders.
The structure of a REIT
When you hear the word REIT, what do you think of?
Sure, you know what it stands for. And yes, you know that it invests in real estate.
But what exactly does that mean?
For starters, it’s important to know that there are many different sectors of REITs. Here they are:
- Office REITs
- Industrial REITs
- Retail REITs
- Lodging REITs
- Residential REITs
- Timberland REITs
- Health care REITs
- Self-storage REITs
- Infrastructure REITs
- Data center REITs
- Diversified REITs
- Specialty REITs
When you invest in a REIT, you are only investing in one sector. For example, if you invest in a self-storage REIT, that REIT will only own self-storage facilities. It won’t also own residential real estate.
This principle applies to every REIT sector on the list with the exception of diversified and specialty REITs, which do invest in multiple sectors in a single REIT.
Additionally, you can also purchase REIT ETFs. These work the same way stock ETFs work in that it holds a basket of different stocks and other securities.
REIT ETFs hold multiple REITs in multiple sectors, all in one fund. This is my preferred method of REIT investing because it gives you more diversification across the real estate market.
Why invest in REITs
According to REIT.com, an estimated 87 million Americans own REITs. However, that’s not why you should invest in them.
Like with any investment, you first need to be sure it aligns with your needs and goals.
You should specifically look at several factors before adding any new investments to your portfolio, including:
- Performance of the investment
- Risk level of the investment, and if it aligns with your investment strategy
- How long you’ll hold the investment
- How much diversification does the investment add to your portfolio
- How hands-on (or hands-off) do you want to be, and does this investment align with that
Once you’ve gone through and checked all those points, and you are sure the investment aligns with your goals, then go for it. Buy the investment.
We’ll discuss all the major benefits of investing in REITs later in this article. However, let’s go over a few brief points now.
For starters, let’s talk about the obvious advantage of investing in REITs. And that is, they allow you to own real estate without all the headaches of owning physical real estate.
You see, although owning physical real estate has many advantages, it is not peachy at all. There is a lot of work involved on the front end and the back end. What does that mean?
Well, depending on if you’re buying the property as a rental, or flipping it for a “quick” profit, that will change the work involved.
For this example, let’s say you’re buying a rental property.
First, on the front end, you have to find a property that fits your criteria as an investment property. Not every property is a suitable investment property. You can’t just go to Zillow, find a cute house in your neighborhood, and click buy now.
Well, technically you could, but you definitely shouldn’t.
Finding an investment property requires weeks of research, knowledge of properties, a healthy credit score, and a decent cash pile (or a partner who has those things).
Then, once you’ve found your investment property, successfully purchased it, and put a tenant in it, there are still things you need to manage on the back end.
For example, what if your tenant stops paying rent, and you have to evict them? In some cases, it can take as long as six months to evict a tenant. There goes six months of rent out the window.
And let’s not forget the maintenance required for a house. What if the air conditioning unit goes out and you have to replace it? That’s a sweet $5,000 out the front door.
Finally, don’t think you’ll be getting away from paying Uncle Sam the property tax you owe him every year. There goes more of your investment returns up and out the chimney. Not to mention home insurance, and all the other maintenance costs required.
Now, of course, all of this is the worst case scenario. In most cases, your tenants will pay on time, and your air conditioning unit will work.
The principle is this: REITs allow you to get most of the benefits of investing in real estate, without real estate headaches.
What type of returns? REITs have historically outperformed the S&P 500 index and other major indexes over the last 20 years. This basically means if you owned an S&P 500 ETF over the last 20 years, and your friend owned a REIT, your friend got a higher return than you did.
Does that mean you should stop investing in the stock market? Absolutely not.
The S&P 500’s historical performance is only one measurement of the stock market’s growth. Many hedge funds have outperformed the stock market by investing in specific sectors and industries.
Another reason to invest in REITs is to diversify your portfolio.
Most investors have portfolios made up of stocks and bonds. Investing in REITs will expose your portfolio to an entirely different industry that has almost no correlation to stocks and bonds—real estate.
Why is that a good thing?
Because if the entire stock market is down, and your portfolio is made up of mostly stocks, then your entire portfolio will be down.
However, if you have investments outside of the stock market, those investments will balance out your portfolio in case of a downturn.
There are more benefits to investing in REITs, but we’ll touch on those shortly in this guide.
Types of REITs
There are four types of REITs. Let’s briefly go over each type.
Equity REITs are the most common type of real estate investment trust. When you see someone talking about a REIT, they are typically referring to an equity REIT.
These REITs own and operate income-producing real estate and are publicly traded on the stock market.
Equity REITs make money from the rent they charge on their properties and pass 90% or more of those profits along to shareholders (you) in dividends.
You can also invest in REIT mutual funds or ETFs, which usually always contain equity REITs.
mREIT stands for mortgage REIT.
Unlike an equity REIT that owns real estate and collects rent, mREITs do not own any real estate or collect any rent.
Instead, they provide financing for the use of purchasing income-producing real estate. Sort of like a bank provides financing for you to buy a home.
An mREIT makes money from the interest on these mortgage loans.
Public non-listed REITs (PNLRs)
Public non-listed REITs, or simply PNLRs, are REITs that operate like equity REITs but do not trade on the stock market.
Because PNLRs are not publicly traded, they are less common to see in investment portfolios. The lack of liquidity makes them less desirable compared to equity REITs or mREITs, both which are publicly traded.
However, although PNLRs are not listed on any stock exchange, they are still required to register with the SEC.
Private REITs are not traded on the stock market and are not required to register with the SEC.
Private REITs are generally sold to institutional investors such as banks, hedge funds, pensions, mutual funds, and insurance companies.
Private REITs also have higher minimum investments ranging from $1,000 to $25,000.
Benefits of REITs
There are always pros and cons to everything in life. In the case of REITs, there are more advantages than disadvantages when it comes to this investment vehicle.
Let’s go over all the benefits of REITs, and what adding them to your portfolio could do.
REITs provide your portfolio with an additional layer of diversification that you won’t find in investments like stocks and bonds.
For starters, REITs invest in real estate. Nothing else. This means your investment is backed by real, tangible assets.
Not only that, but REITs have little correlation with other popular investments like stocks and bonds. This is a good thing. It means that if the entire stock market is down, your entire portfolio won’t be affected because your REIT investment will likely still be strong.
Liquidity is a term used to describe how fast an asset can be converted into cash while still maintaining its value. For example, stocks are very liquid because you can buy and sell them quickly on the stock market for cash.
It makes sense then that cash is the most liquid asset you can own.
On the contrary, the home that you live in is not liquid, because it can take months, sometimes years to list and sell on the housing market. During that period, the value of the house could change significantly.
Because REITs trade on the stock market, they are naturally very liquid and can easily be bought and sold while the market is open during the day.
But why is liquidity in your portfolio important?
The answer is simple: unexpected events.
Suppose you experienced an unpredictable expense in your life, or another 2008 financial crisis situation happens. In that case, you want to ensure that at least part of your portfolio is liquid and can be easily converted into cash quickly.
REITs pay quarterly dividends to shareholders, similar to a dividend stock.
In fact, REITs are required by law to payout at least 90% of its taxable income to shareholders. This includes income from rent on equity REITs and interest on mortgage REITs.
Dividends can be especially nice if you are trying to create passive income. Many investors use a mixture of REITs and dividend stocks to earn over six figures per year from their dividend payments alone.
» Want more passive income?: 21 Best Ways to Make Your Money Work for You
REITs have a history of outpacing both the S&P 500 and physical real estate investing.
For example, according to the NCREIF, from 1994 to 2019, the S&P 500 index had an average return of 9.8%.
Meanwhile, real estate investment trusts (REITs) had an average return of 10.5%.
That may not seem like a big difference, but when it comes to getting a return on your investment, every bit counts.
How to start investing in REITs
Once you’ve done your research on the type of REIT you’d like to invest in, it’s time to start investing.
Best REITs to invest in:
- QTS Realty Trust (QTS)
- Equinix (EQIX)
- Digital Realty Trust (DLR)
- American Tower Corp. (AMT)
Best REIT ETFs to invest in:
- Vanguard Real Estate ETF (VNQ)
- iShares Core U.S. REIT ETF (USRT)
- Fidelity MSCI Real Estate Index ETF (FREL)
- SPDR Dow Jones REIT ETF (RWR)
Buying REITs is like buying stocks in a company. You open your brokerage account, type in the trading symbol (also known as the ticker), enter in how many shares of the REIT you want to buy, and then execute your order.
You can start investing in REITs with any broker. If you already have a brokerage account that you are happy with, just use that broker.
I’d recommend using M1 Finance if you are completely new to investing and would like a more hands-on approach to setting up your portfolio and buying REITs.
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M1 Finance also has expert pre-built portfolios that you can invest in and get the same results from even billionaire-dollar hedge funds.
Use Webull if you are not new to investing and feel comfortable buying REITs on the stock market. Webull offers $0 commission and $0 fees on all trades. The service is completely free.
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