Investing in real estate can be an attractive way to put your money to work for you — but what if you don’t have enough money to buy property outright? One way to start investing in real estate without the need for a large chunk of capital is to buy shares of a real estate investment trust, or REIT.
What is a real estate investment trust (REIT)?
A real estate investment trust (REIT) is a company that owns, finances or manages properties that generate income. This income can come from mortgage payments, for example, or the rents that the properties’ tenants pay. Many REITs specialize in a specific type of property, but others have more diverse portfolios.
With a REIT, you have access to real estate investment opportunities without the need for a substantial amount to actually purchase property or buy into a real estate investment club.
There are publicly traded and non-traded REITs, but the majority are publicly traded. Like any other stock, shares of publicly traded REITs can be bought and sold on the major exchanges.
In essence, a REIT profits from its real estate holdings, and you, as a shareholder, have a chance to profit as well. When the REIT’s share price increases, it’s possible to take advantage of the capital appreciation, in addition to receiving dividend payouts.
How does a REIT work?
In order to be considered a REIT, a company must meet certain criteria:
- At least 75 percent of the company’s assets must be invested in real estate.
- At least 75 percent of the company’s gross income must come from interest on mortgages, sales of real estate or rents received from properties.
- The company must be taxed as a corporation and managed by trustees or a board of directors.
- There must be at least 100 shareholders, and no more than 50 percent of its shares can be held by five or fewer people.
- At least 90 percent of a REIT’s taxable income each year must be paid out to shareholders as dividends.
Types of REITs
There are two main types of publicly traded REITs:
- Equity REITs – Equity REITs are often referred to simply as REITs. These REITs actually own properties that produce income, such as apartment buildings, commercial buildings and other types of properties, like storage facilities. They own these assets and make money as their tenants pay rent, or when they sell properties at a gain.
- mREITs – Rather than buying properties and charging rent, mREITs (or mortgage REITs) provide financing for real estate. They might purchase mortgages, or even originate them, or buy mortgage-backed securities. The income for this type of REIT comes from the interest earned on these mortgages.
In addition, there are public non-listed REITs that don’t trade on exchanges, even though they’re registered with the Securities and Exchange Commission (SEC).
There are also private REITs that aren’t registered with the SEC and can be bought without going through an exchange. However, these might be less liquid and transparent than public REITs, so they come with some risk.
Along with exchange status, a REIT can fall into the following property sectors:
- Data centers
- Diversified (or a combination of properties)
- Industrial (e.g., warehouses)
- Infrastructure (e.g., energy pipelines)
- Mortgage (mREIT)
- Specialty (e.g., casinos)
How to invest in REITs
Investing in REITs is fairly straightforward, especially if you focus on publicly traded companies. In that case, all you need to know is the ticker symbol. You can then go to your broker and buy shares, placing an order like you would for any other stock. You can also buy shares in REIT funds.
On top of that, you might be able to allocate a portion of your regular 401(k) contribution to a REIT. While individual equities aren’t normally included in a 401(k), REITs can be added if your administrator allows it.
As with any investment, keep in mind that there’s a level of risk with REITs, and they were considerably impacted at the onset of the pandemic. To avoid missteps, be sure to analyze each opportunity carefully, and try to steer clear of a “one-size-fits-all” strategy.
Do REITs have a good track record?
In general, REITs have a relatively good track record.
The FTSE Nareit All Equity REITs index recorded annualized returns of approximately 12 percent over the 40-year period ending June 2019, according to Nareit, an association that represents REITs. By comparison, the S&P 500 historically sees annualized returns close to 10 percent. While some indexes, like the Russell 2000 Small-Cap, outperform REITs over shorter periods of time, REITs tend to see better performance in the long run.
It’s important to note, however, that past performance isn’t a guarantee that REITs will continue performing well in the future.
Depending on your risk tolerance and portfolio goals, though, adding some real estate exposure through REITs could help you further diversity and provide you with another asset class. Carefully consider your individual situation, as well as consulting with an investment professional, to decide if investing in real estate or focusing on REITs makes sense for you, and how much you should allocate to them.