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REIT investing (real estate investment trust) is a great way for investors to profit from realty income dividends without having to buy or manage property.
With REITs, any investor can get started with investing in real estate, no matter how much or how little money they are able to invest. But with so many different types, where do you start, and which REIT or REIT fund is right for you?
If you're ready to start earning a passive income from real estate investing or are curious if REITs are a good investment, there are a few things you should know.
Read on to learn about the benefits of REIT investing.
What Is a REIT
REIT (pronounced "reet") is short for real estate investment trust.
A REIT is a company that pools together money from a group of investors to own, finance, or operate income-generating real estate.
REIT dividends may yield higher returns than traditional stocks, making them a valuable part of a well-diversified portfolio for income-seeking investors.
REITs are a form of income investing for retirement that was modeled after mutual funds. Investors buy shares in the company and effectively own a portion of the real estate owned by the company.
Over the years, REITs have delivered solid, long-term returns and served as a way for investors to further diversify their portfolios. An average return for all REITs in 2019 was 11.6%. Certain REITs, such as manufactured home REITs and industrial REITs outperformed the average with a 49.09% and 48.71% average return, respectively.
A good investment strategy and knowledge of REITs can lead investors to big returns.
How Do REITs Work?
REITs were created by the Cigar Excise Tax Extension of 1960 as a way of allowing ordinary investors to get involved in real estate.
Although REITs function much like a mutual fund, where investors buy shares in a managed portfolio, REIT companies are required by law to meet specific IRS standards.
REITs must have at least 100 members after their first year, with no more than half of the shares held by five or fewer members. They also have to earn at least 75% of their gross income from real estate-related sources and invest at least 75% of their assets in real estate.
Additionally, 90% have to be paid to shareholders, making REIT dividends much higher than other stocks. This requirement makes REIT investing extra appealing to investors who want the benefits of real estate investing without having to buy property.
Companies that meet REIT requirements can then sell shares and use the money from sales to invest in real estate, whether it is property ownership, loans and mortgage REITs, or a combination of both. Shareholders own a portion of all of the properties and loans a REIT company owns.
What Are the Different Types of REITs?
The best REITs to invest in depends on which sector you want to invest in.
REITs can be classified in several ways. One is by the real estate sector in which they invest. For example, a healthcare REIT invests in medical property such as hospitals while hotel REITs, industrial REITs, and warehouse REITs offer different types of properties in which to invest.
Real estate investors with an interest in tech can buy shares in data center REITs or cell tower REITs, and those interested in agriculture or ecology can invest in a farmland REIT or green REITs, respectively.
REITs are also divided by the types of investments they make. There are three main types of REITs:
An equity REIT is one in which the company buys and owns real estate. In many cases, the REIT company acts as the landlord-collecting rent and providing necessary upkeep. Collected rent is then reinvested and distributed to shareholders.
A mortgage REIT has the potential to be a high yield REIT. In a mortgage REIT, the company buys mortgages from other lenders rather than owning property. The REIT collects monthly payments and profits from the interest. Mortgage REITs are usually seen as riskier than equity REITs, but they can also be REITs with the highest dividends.
A hybrid REIT is, as the name suggests, a combination of the other two types of REITs. In a hybrid, the REIT company features both the properties it owns and the mortgages it buys in its portfolio.
REITs are further classified by how they are traded. Publicly traded REITs are traded just like stocks and can be purchased with any brokerage account. Public non-traded REITs aren't listed on stock exchanges and can only be purchased by brokers. Finally, private REITs are not listed and have no impact on the stock market and are therefore exempt from SEC regulations.
Investors having a hard time deciding which REIT is right for them can look at real estate mutual funds or REIT ETFs that help diversify your portfolio of REITs at lower prices.
Why You Should Consider REIT Investing
REIT investing is appealing to many who play the market because of its potential for high ROI.
In 2019, REITs outperformed the S&P 500 Index, boasting an average ROI of 10.5% compared to the S&P 500's 9.8%. Additionally, because REITs are required to pay out 90% of their profits, they are known for paying steady, large dividends year over year. The large REIT dividends can serve as a way of hedging against the volatility of other assets you may own.
While some investors get worried about large amounts of debt that REIT companies often accrue, many REITs have long-term contracts with their properties and therefore have a reliable, steady stream of income that is shared with investors.
By adhering to stringent IRS rules, REITs pay no taxes-leaving their investors to pay taxes on their dividends when they file their income tax. However, there is good news for REIT investors: A 2017 tax bill included a "pass-through deduction" which allows investors to deduct as much as 20% of their REIT dividends from their taxable income. Due to the tax benefits of REITs, REITs are able to finance real estate at a lower cost than other companies and pass those savings on to investors.
Ultimately, REIT investing is a low-cost way to get involved in the world of real estate. A sector that can produce big dividends and that would otherwise be too expensive to attract many investors.
How to Get Started with REIT Investing
Ready to get started in REIT investing? In most cases, it's as easy as pressing a button.
To start purchasing shares in many publicly-traded REITs, you simply need to open an online brokerage account and choose from among the top REITs.
Private market REITs can be a little trickier. First, you will need to talk to a professional broker or institutional investors who have access to the REIT, either directly or through their network.
Additionally, most private REITs have high minimum investments which are meant to keep the trusts available only to experienced, wealthy investors.
If you are having a hard time choosing the right REIT, consider investing in a REIT ETF or a real estate mutual fund. You can speak with an accredited broker or financial planner about mutual funds or search for ETFs on investment platforms.
REIT investing allows any type of investor to see realty income dividends with minimal risk. A REIT is a valuable part of any portfolio for a variety of reasons.
Before investing consider these important aspects of REITS:
- REITs offer access to real estate investing without having to finance the purchase of property.
- Investors buy shares in REIT companies and therefore own a piece of all the property the company owns.
- There are three main classifications of REIT: equity which buys real estate; mortgage which buys loans; and hybrid which buys a bit of both.
- REITs with monthly dividends are less common than those that pay quarterly.
- REITs must adhere to strict IRS rules, including paying 90% of income to shareholders.
- Adhering to such rules affords REITs a tax-exempt status, allowing them to finance real estate more cheaply and offer lower costs to investors.
- On average, REITs outperform the S&P 500 Index.
- Getting started in REIT investing is easy; many publicly-traded REITs can be accessed from any trading platform.
For more information on how to prepare for a comfortable retirement, read the rest of our income investing for retirement guide. Or, check out our in-depth guide to REIT investing for information on the best REITs for dividends and more.