Real estate investment trusts (REITs) are a key consideration when constructing any equity or fixed-income portfolio. They can provide added diversification, potentially higher total returns, and/or lower overall risk.
In short, their ability to generate dividend income along with capital appreciation makes them an excellent counterbalance to stocks, bonds, and cash.
- Using REITs to invest in real estate can diversify your portfolio, but not all REITs are created equal.
- Some REITs invest directly in properties, earning rental income and management fees. Others invest in real estate debt, i.e., mortgages and mortgage-backed securities.
- In addition, REITs tend to focus on a specific sector of properties such as retail or shopping centers, hotels, and resorts, or healthcare and hospitals.
- One of the biggest benefits of REITs is their high-yield dividends. REITs are required to pay out 90% of taxable income to shareholders.
- Most REIT dividends don’t meet the IRS definition of “qualified dividends.”
1. Retail REITs
Approximately 24% of REIT investments are in shopping malls and freestanding retail.3 This represents the single biggest investment by type in America. Whatever shopping center you frequent, it’s likely owned by a REIT.
2. Residential REITs
These are REITs that own and operate multi-family rental apartment buildings as well as manufactured housing. When looking to invest in this type of REIT, one should consider several factors before jumping in.
For instance, the best apartment markets tend to be where home affordability is low relative to the rest of the country. In places like New York and Los Angeles, the high cost of single homes forces more people to rent, which drives up the price landlords can charge each month. As a result, the biggest residential REITs tend to focus on large urban centers.
3. Healthcare REITs
Healthcare REITs will be an interesting subsector to watch as Americans age and healthcare costs continue to climb. Healthcare REITs invest in the real estate of hospitals, medical centers, nursing facilities, and retirement homes.
The success of this real estate is directly tied to the healthcare system. A majority of the operators of these facilities rely on occupancy fees, Medicare and Medicaid reimbursements as well as private pay. As long as the funding of healthcare is a question mark, so are healthcare REITs.
4. Office REITs
Office REITs invest in office buildings. They receive rental income from tenants who have usually signed long-term leases. Four questions come to mind for anyone interested in investing in an office REIT.
- What is the state of the economy and how high is the unemployment rate?
- What are vacancy rates like?
- How is the area in which the REIT invests doing economically?
- How much capital does it have for acquisitions?
5. Mortgage REITs
Approximately 10% of REIT investments are in mortgages as opposed to real estate itself.3 The best-known but not necessarily the greatest investments are Fannie Mae and Freddie Mac. They are government-sponsored enterprises that buy mortgages on the secondary market.
Just because this type of REIT invests in mortgages instead of equity doesn’t mean it comes without risks. An increase in interest rates would translate into a decrease in mortgage REIT book values, driving stock prices lower.
In addition, mortgage REITs get a considerable amount of their capital through secured and unsecured debt offerings. Should interest rates rise, future financing will be more expensive, reducing the value of a portfolio of loans.
How to Invest in REITs
As referenced earlier, you can purchase shares in a REIT that’s listed on major stock exchanges. You can also buy shares in a REIT mutual fund or exchange-traded fund (ETF).
To do so, you must open a brokerage account. Or, if your workplace retirement plan offers REIT investments, you might invest with that option. Check with your plan administrator to see what REIT investments are available.
If you decide to open a brokerage account (and don’t already have one), the process is straightforward. You’ll provide basic contact details and certain personal details (e.g., Social Security number and a valid ID). You’ll be asked for some additional information about your income, occupation, and investing experience.
Depending on which broker you choose, you’ll be able to sign up online at their website or mobile app, or in person at a branch location.
Once your account is open and you can access it online, use the education and research tools available to begin reviewing possible REIT investments. Your brokerage account should also have a screening tool that can assist you in fine-tuning your research and selection.
Once you’ve chosen the REIT investment that best fits your financial needs and investment goals, you can proceed to buy it online. Before you do, make sure you understand the nature of fees that your broker may charge and fees/expenses associated with the actual investment (such as fund expense ratios).
Just as with your other investments, you’ll want to monitor your REIT investment periodically.
Are REITs Good Investments?
Investing in REITs is a great way to diversify your portfolio outside of traditional stocks and bonds and can be attractive for their strong dividends and long-term capital appreciation.
What REITs Should I Invest in?
Each type of REIT has its own risks and upsides depending on the state of the economy. REIT investing through a REIT ETF is a great way for shareholders to engage with this sector without needing to personally contend with its complexities.
How Do You Make Money on a REIT?
Since REITs are required by the IRS to pay out 90% of their taxable income to shareholders, REIT dividends are often much higher than the average stock on the S&P 500. One of the best ways to receive passive income from REITs is through the compounding of these high-yield dividends.
Can You Lose Money on a REIT?
As with any investment, there is always a risk of loss. Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds.
Are REITs Safe During a Recession?
Investing in certain types of REITs, such as those that invest in hotel properties, is not a great choice during an economic downturn. Investing in other types of real estate such as healthcare facilities or retail is a great way to hedge against a recession. They have longer lease structures and thus are much less cyclical,
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