Real estate investment trusts (REITs) own a basket of properties, ranging from malls to movie theaters, apartment buildings to office parks, hotels to hospitals. A REIT may specialize in a certain real estate sector, or it may diversify into a variety of property types. Investing in REITs is appealing for several reasons, especially for income-oriented investors. And while there are current risks for the REIT market as a whole, over the long term, REITs have proven to be winners.
What to Look for in a REIT
For retail investors, REITs hold several advantages over investing in real estate itself. First of all,your investment is liquid. You can buy and sell shares of REITs, which trade like stocks on an exchange. Shares of REITs have low investment minimums, as well; investing directly in an actual property often requires a much more sizable commitment.
REITs generate income from the rents and leases of the properties they own. The majority (90%) of a REIT’s taxable income must be returned to shareholders in the form of dividends. As a result, investors often rely on REITs as providers of a steady cash flow, though the shares can also appreciate in value if the real estate holdings do.
When you’re ready to invest in a REIT, look for growth in earnings, which stems from higher revenues (higher occupancy rates and increasing rents), lower costs, and new business opportunities. It’s also imperative that you research the management team that oversees the REIT's properties. A good management team will have the ability to upgrade the facilities and enhancethe services of an underutilized building, increasing demand.
REIT Caveats
It’s important that you don’t think of REITs as an investment asset in themselves. You need to look at industry trends prior to determining what type of REIT is best for your portfolio.
For instance, mall traffic has been declining due to the increased popularity of online shopping and the decline of suburban neighborhoods (this is the first time since the 1920s that urban growth has outpaced suburban growth). So, REITs that are exposed strictly or heavily to malls will present more risk than those investing in other sorts of real estate.
Or take hotels. To invest in a REIT that focuses on them is to invest in the travel industry. While the industry may be doing well at a given moment, hotels have the potential to be hit by reduced business travel as companies look for ways to cut costs, and web conferencing becomes more common.
In terms of general economic trends, low inflation and lack of wage growth – such as the U.S. has experienced in the 2000s – often limits growth potential for REITs, since they put a damper on rent increases. Even so, REITs have been performing well in the face of these headwinds.
A Far-Thinking REIT
The key is to be forward-looking. For example, millennialsfavor urban living to suburban living, a trend that has led to the aforementioned decline in suburban mall traffic and an increase in street retail (urban shopping strips anchored by a grocery or other major retailer). One REIT spotted the trend early and has set itself up accordingly.
Acadia Realty Trust (AKR) focuses on urban areas with high barriers to entry that aresupply-constrained and highly populated. It also takes the approach of not falling in love with one particular retailer, because a popular retailer today might not be a popular retailer tomorrow. Instead, it invests in a street, block, or building, allowing it always to make adjustments so hot retailers are in place. But what’s most important here is that by investing heavily in street retail, Acadia Realty Trust has looked down the road, literally, more than its peers. With a market cap of $1.37 billion, the REIT has 84 properties in its core portfolio, totaling 4.2 million square feet; as of October 2018, it had a dividend yield of 3.6%.
The Bottom Line
Despite the advantages, nobody should invest solely in REITs. As with any asset class, these should always be a portion of a diversified portfolio.
Dan Moskowitz does not have any positions in AKR.
FAQs
You can buy and sell shares of REITs, which trade like stocks on an exchange. Shares of REITs have low investment minimums, as well; investing directly in an actual property often requires a much more sizable commitment. REITs generate income from the rents and leases of the properties they own.
Are REITs a good investment for beginners? ›
You get steady dividends
Since REITs are legally required to pay out 90% of their annual income as shareholder dividends, they consistently offer some of the highest dividend yields in the stock market. This makes REIT investing a favorite among those looking for a steady stream of income.
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.
Is there a downside to investing in REITs? ›
Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
What is the 5 50 rule for REITs? ›
General requirements
A REIT cannot be closely held. 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).
Can I invest $1000 in a REIT? ›
While they aren't listed on stock exchanges, non-traded REITs are required to register with the SEC and are subject to more oversight than private REITs. According to the National Association of Real Estate Investment Trusts (Nareit), non-traded REITs typically require a minimum investment of $1,000 to $2,500.
Do REITs pay monthly? ›
REITs and stocks can both pay dividends, usually on a monthly, quarterly, or yearly basis. Some investments will also offer special dividends, but they're unpredictable.
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 bad income for REITs? ›
For purposes of the REIT income tests, a non-qualified hedge will produce income that is included in the denominator, but not the numerator. This is generally referred to as “bad” REIT income because it reduces the fraction and makes it more difficult to meet the tests.
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.
Conclusion. Warren Buffet prefers to invest in REITs instead of real property because they are a great source of passive income, are reward-oriented, and are more liquid than property ownership.
Why I don t invest in REITs? ›
However, REITs are not risk-free: they may have highly inconsistent, variable returns; are sensitive to interest rate changes are liable to income taxes may not be liquid, and can be dramatically affected by fees.
Are REITs good for passive income? ›
If you are looking to tap into a new source of funds for retirement, then real estate investment trusts (REITs) are a popular way to build a reliable passive income stream. REITs generate cash flow through rent or sales, and legally must pass on the majority of their profits to shareholders as dividends.
How do I make money from REITs? ›
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.
What disqualifies a REIT? ›
A company will be disqualified as a REIT if, after the first taxable year, more than 50% of its shares is owned directly or indirectly by five or fewer individuals.
How to tell if a REIT is good? ›
The 3 most common metrics used to compare the relative valuations of REITs are:
- Cap rates (Net operating income / property value)
- Equity value / FFO.
- Equity value / AFFO.
The Cheapest Option: REITs—$1,000 to $25,000 or more
A REIT offers the investor a relatively high dividend as well as a highly liquid method of investing in real estate. Most real estate investments are not easy or quick to get out of. An exchange-traded REIT is. Moreover, you can start small with a little bit of cash.
What is the average return on a REIT? ›
REITs are also attractive thanks to their market-beating returns. During the past 25 years, REITs have delivered an 11.4% annual return, crushing the S&P 500's 7.6% annualized total return in the same period.
Do REITs have high returns? ›
The beauty of REITs for income investors is that they are required to distribute 90% of their taxable income to shareholders annually in the form of dividends. In return, REITs typically do not pay corporate taxes. As a result, many of the 200+ REITs we track offer high dividend yields of 5%+.
