10 Things You Should Know About REITS (2024)

Real estate can create a more balanced investment portfolio. A portfolio with between 5% and 20% of real estate has better returns and less risk than a portfolio only of stocks and bonds, according to a meta-analysis of academic articles by Morningstar. But for most investors, that might not justify the headaches of managing tenants and repairs for a rental property. A real estate investment trust, a.k.a. a REIT, could be a more convenient solution.

“A REIT is a fund that buys real estate for investors,” says Lee Harbaugh, a real estate agent in Mansfield, Texas. “It’s a passive way to get real estate exposure where you don’t have to worry about buying or selling properties yourself.”

REITs first emerged in the 1960s and now have more than $4 trillion in assets. That’s still a fraction of the money in stocks and mutual funds. “Asset managers like REITs for portfolio reasons, but I don’t typically have clients asking about them. They’re underutilized,” says Justin Stivers, a financial adviser and estate planning attorney in Coral Gables, Fla.

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Here’s what to know about REITs:

1. REITs operate like mutual funds for real estate

REITs raise a pool of money from many investors and then buy and run income-generating real estate properties. Some possibilities include apartment buildings, shopping malls, hospitals, office parks, warehouses and storage units. “There’s no way you could buy a mall on your own, but through a REIT, you can invest in one,” says Harbaugh.

As an investor, you purchase shares of a REIT. You then receive a portion of the profits from rental income and property sales as dividends. For example, Digital Realty Trust (stock symbol DLR) invests in data centers. It pays a quarterly dividend with a quarterly yield of 3.6% that has gone up every year since 2005 while shares are up more than 20% over the past year. CubeSmart (CUBE) runs self-storage facilities. It has a 4.67% dividend yield and an 11.03% three-year return.

Professionals working for the REIT research, manage, buy and sell properties on behalf of the investors. In exchange, the REIT could charge fees when you buy shares, ongoing annual management fees and fees for buying and selling properties. The fee structure depends on the REIT.

2. REITs must prioritize short-term income for investors

By law, a REIT must distribute at least 90% of its taxable income annually to shareholders. They pay out stable dividends, provided the properties are doing well,“ says Stivers, the financial advisor from Florida.

In exchange for more ongoing income, REITs have less to invest for future returns than a growth mutual fund or stock. “REITs are better for short-term cash flow and income versus long-term upside,” says Stivers.

3. REITs use a special structure to help with taxes

Unlike most corporations that pay income tax on profits and then investors pay tax again on dividends, most REITs avoid double taxation by paying out 100% of their taxable income to investors — who then pay ordinary income tax rates rather than lower capital gains rates.

But the REIT could choose to reduce taxes further by claiming depreciation and amortization deductions for the properties. This turns a portion of your dividend into a tax-free return of capital. It reduces how much you owe per year for the dividend income, but also reduces your tax-basis in the REIT. You’d owe a larger capital gain for selling the shares at a profit in the future. You can defer all those taxes if you buy a REIT through your Individual Retirement Account (IRA) or 401(k).

4. Publicly traded REITs are liquid, private REITs are not

10 Things You Should Know About REITS (2)

(Image credit: Getty Images)

Publicly traded REITs register with the SEC as securities. They can then be listed and traded on the major stock exchanges. Anyone can buy and sell them.

Private REITs generally offer a higher return in exchange for less liquidity. Private REITs do not register with the SEC and do not allow investors to trade shares freely. (Private REITS are open only to high net worth accredited investors.) Instead, you buy and sell directly from the company running the REIT. Private REITs lock up your money with minimal liquidity. You typically agree to keep your money in the REIT for three to 10 years. The private REIT might allow some early redemptions to cash out before then, but it might not.

5. REITs can specialize in different real estate investments

Equity REITs focus only on buying properties. They are the most common. There are also mortgage REITs that invest in mortgage loans and mortgage-backed securities. Finally, there are hybrid REITs that invest in both properties and mortgages.

Large public REITs typically include various property types across different regions. Some REITs specialize in certain areas and properties. For example, a hospitality REIT might only invest in hotels, motels and resorts. “As an investor, you could lean into a market where you have a specialty understanding. Perhaps if you were an office park manager, you’d prefer an office REIT,” says Ken Johnson, real estate economist and business professor at Florida Atlantic University in Boca Raton.

6. REITs help with diversification and inflation

Real estate as an asset class performs differently than stocks.The FTSE All Equity REITs sums up the return of all publicly traded U.S. REITs. One the long haul, the annual return is similar to the S&P 500. In 2023, the FTSE All Equity REITs fund only grew by 11.4% versus 26.29% for the S&P 500 due to high-interest rates.

REITs and real estate usually do well as an inflation hedge, a situation when stocks and bonds have historically struggled. In 2021, when post-pandemic inflation was soaring and bonds were crashing, the FTSE All Equity REITs grew by 41%, outperforming the S&P 500.

7. Returns depend on interest rates

10 Things You Should Know About REITS (3)

(Image credit: Getty Images)

When interest rates go up, REITs tend to struggle. Higher rates increase real estate borrowing costs and push down the value of properties. REITs have taken hits over the past couple of years as the Fed rapidly increased rates to control inflation. If the Fed stops tightening and starts lowering interest rates, that could boost the future performance of REITs, says Johnson, the real estate economist from Boca Raton.

8. Commercial property REITs are in trouble

The commercial real estate property market has taken a pounding from high vacancies due to the rise of remote work. The number of commercial properties in financial distress hit a 10-year high in late 2023, the highest since the financial crisis. This is dragging the performance of commercial REITs.

For example, the Gladstone Commercial Corp. (GOOD) specializes in office space. It’s down nearly 14% over the past year and is liquidating its commercial properties to focus on retail and industrial properties. On the other hand, Park Hotels and Resorts (PK) is up around 22% over this same period as consumer demand for travel and entertainment remains strong.

9. The fund matters for performance

Some REITs are better run and earn more than others. “You need to trust the companies running the properties know what they’re doing, especially with the ongoing slowdown in commercial real estate,” says Stivers.

Before investing in a REIT, pull up its historical returns for the past few years to compare against other REITs. Many REITs list their properties on their corporate web sites. “We do a Google search for reviews on the properties to see what tenants think,” says Stivers. You could check a fund’s credit rating and debt for stability. Too much debt could be a sign that a REIT is overextended.

Finally, REITs report their market price to funds from operations (FFO). A lower ratio is a sign that the REIT is a better value in the same way that a low price-to-earnings ratio is a sign of a better-valued stock.

10. REITs usually match the returns of owning properties

Buying your own properties involves much more work than a REIT but doesn’t generate extra returns for most investors. “If you’re the go-to house flipper in your community with lots of local connections, you could make more. But 99% of investors interested in real estate make just as much if not more with a REIT,” says Harbaugh, the Texas real estate agent.

With a REIT though, you aren’t able to deduct all the tax breaks you get from buying your own properties, such as depreciation, the cost of repairs, property taxes and mortgage interest. Operating REIT properties is up to the fund manager. “Some people enjoy having the ultimate say of what gets bought, the tenants and how a building is run,” says Harbaugh. “If you want to be in control, you’ve got to do it yourself.”

Note: This item first appeared in Kiplinger’s Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement.Subscribe for retirement advicethat’s right on the money.

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10 Things You Should Know About REITS (2024)

FAQs

10 Things You Should Know About REITS? ›

Key Takeaways. A REIT is a company that owns, operates, or finances income-producing properties. REITs generate a steady income stream for investors but offer little capital appreciation. Most REITs are publicly traded like stocks, which makes them highly liquid, unlike real estate investments.

What do you need to know about REITs? ›

Key Takeaways. A REIT is a company that owns, operates, or finances income-producing properties. REITs generate a steady income stream for investors but offer little capital appreciation. Most REITs are publicly traded like stocks, which makes them highly liquid, unlike real estate investments.

What is the 90% rule for REITs? ›

To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.

What is the 5 and 50 rule for REITs? ›

A REIT will be closely held if more than 50 percent of the value of its outstanding stock is owned directly or indirectly by or for five or fewer individuals at any point during the last half of the taxable year, (this is commonly referred to as the 5/50 test).

What is the downside of REITs? ›

Non-traded REITs have little liquidity, meaning it's difficult for investors to sell them. Publicly traded REITs have the risk of losing value as interest rates rise, which typically sends investment capital into bonds.

How do REITs pay out? ›

The common denominator among all REITs is that they pay dividends consisting of rental income and capital gains. To qualify as securities, REITs must payout at least 90% of their net earnings to shareholders as dividends.

Are REITs worth owning? ›

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 is the REIT 10 year rule? ›

For Group REITs, the consequences of leaving early apply when the principal company of the group gives notice for the group as a whole to leave the regime within ten years of joining or where an exiting company has been a member of the Group REIT for less than ten years.

What is the 75 75 90 rule for REITs? ›

Invest at least 75% of its total assets in real estate. Derive at least 75% of its gross income from rents from real property, interest on mortgages financing real property or from sales of real estate. Pay at least 90% of its taxable income in the form of shareholder dividends each year.

Are REITs double taxed? ›

Unlike many companies however, REIT incomes are not taxed at the corporate level. That means REITs avoid the dreaded “double-taxation” of corporate tax and personal income tax. Instead, REITs are sheltered from corporate taxes so their investors are only taxed once.

What are the dangers of REITs? ›

Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.

Can REITs go broke? ›

Real estate equity REITs are gonna be in trouble,” Howard Lutnick, Cantor Fitzgerald chairman and CEO, said in an interview with Fox Business this month. “A lot of them are gonna get wiped out. I think $700 billion could default. “There's going to be selling,” Lutnick said.

Why are REITs struggling? ›

Here's an explanation for how we make money . More than a year of interest rate hikes by the Federal Reserve pushed down returns on real estate investment trusts, or REITs. While higher rates negatively impacted nearly every sector of the economy in 2022 and most of 2023, real estate was hit especially hard.

How do you make money from REITs? ›

Properties can generate rental income, which, after collecting fees for property management, provides income to its investors. These REITs generate income from renting real estate to tenants. After paying expenses for operation, equity REITs pay out dividends to their shareholders on a yearly basis.

How much do you need to start investing in REITs? ›

The Cheapest Option: REITs—$1,000 to $25,000 or more

These are securities and are traded on major exchanges like stocks. They invest in real estate directly, either through property purchases or through mortgage investments.

How do you know if a REIT is good? ›

The 3 most common metrics used to compare the relative valuations of REITs are:
  1. Cap rates (Net operating income / property value)
  2. Equity value / FFO.
  3. Equity value / AFFO.

Do REITs pay taxes? ›

REITs generally don't pay taxes themselves as long as they distribute at least 90% of their income to shareholders.

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