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Are you considering investing in real estate? If so, a Real Estate Investment Trust (REIT) may be the perfect option for you! REITs are designed to enable investors to acquire a stake and gain benefits from owning property without having to buy it outright. Not only do they offer diversification away from traditional stocks and bonds, but they also have tax advantages that make them attractive investments.
In this blog post, we'll dive deep into the world of REITs and explore how they work, why they're beneficial for investors looking to expand their investment portfolio beyond typical investments options such as stocks or bonds, and how you can begin taking advantage of investing in real estate companies or portfolios. So if you're ready to learn more about real estate investment trusts, let's get started!
Real Estate Investment Trust (REIT) Overview
Investing in real estate is not necessarily something that every individual can do on their own, but fortunately, there is a way to take part in large-scale real estate asset investments without being tied to the daily management or financing of properties. Real estate investment trusts, or REITs, make it possible to achieve this, allowing everyday investors to buy into larger rental income-generating properties that are professionally managed by a specialized team.
All you have to do is choose your REIT or exchange-traded fund and start earning money from dividends—all without having property ownership headaches! It's no wonder REITs have grown so much in popularity as investors seek new ways to add value and diversity to their portfolios. With the right REIT, investors can receive a steady stream of taxable income without having to worry about all the time and energy requirements that typically accompany property ownership.
How REITs Work?
Investing in finance real estate has been around since the dawn of civilization. Yet, it wasn't until Congress passed the Cigar Excise Tax Extension in 1960 that buying into a commercial real estate portfolio became accessible to those other than the wealthy or institutional investors.
Now, through Real Estate Investment Trusts (REITs), individuals can take their pick from an impressive variety of properties on the market—from traditional investments like apartments and office buildings to more tech-based holdings such as data centers and energy pipelines. Plus, with healthcare facilities, hotels, retail space, self-storage operations, timberlands, and warehouses also trading as REITs, investing has become simpler and more exciting than ever before.
Real Estate Investment Trusts (REITs) provide investors access to a wide variety of real estate properties. While some specialize in one specific sector, diversified and specialty REITs take many forms and have various property types such as office, retail, or even hotel included in their portfolios. There are a never ending list of options, depending on your real estate investing needs and interests.
Additionally, many REITs are publicly traded REITs and on major exchanges, and they offer high levels of liquidity; investors can easily buy or sell them like stocks at any time during market hours without difficulty due to the substantial trading volume. Therefore, by owning REITs, one has an excellent opportunity to efficiently get exposure to real-estate markets without the illiquidity of the slow sales cycle in real estate.
What Is Required to Qualify as a REIT?
To qualify as a Real estate investment trust, a company must follow specific regulations set forth by the Internal Revenue Code (IRC), including the majority ownership of income-generating real estate and the distribution of that income to shareholders. Most REITs achieve this by collecting revenue in the form of rent and distributing a percentage of the cashflow after all the expenses are paid. These REITs provide an investment opportunity for investors as well as a reliable income stream from both cash from leases or investments and potential capital gains from increases in property valuation.
In contrast, Mortgage REITs (mREIT) seek an alternate method of generating funds - through investments in mortgages and the collection of interest on those investments. Specifically, these include investing at least 75% of total assets into real estate, cash, or U.S. Treasuries; generating at least 75% of gross income from rents and interest on mortgages that finance real property or real estate sales; and paying out a minimum of 90% of taxable income in the form of shareholder dividends each year.
Additionally, REITs must be entities that are taxable as corporations with a board of directors or trustees managing it and have no more than 50% of its shares held by five or fewer individuals with a minimum of 100 shareholders after its first year of existence.
With such requirements to meet and benefit investors seeking to diversify their investment portfolios with real estate options, REITs offer an interesting opportunity to enter unchartered waters.
Types of REITs
Equity REITs
Equity REITs are a form of real estate investment trust that make money by collecting rents from their tenants. As opposed to other forms of REITs, such as mortgage REITs, equity REITs make money primarily through direct ownership and the operation of income-producing real estate.
This means that their revenues are not derived from the sale or exchange of properties but rather from the financial return generated by the rental of the property to its tenants. Equity REITs provide investors with an easy way to invest in real estate and benefit from higher potential returns than they can generate with other investments. Additionally, the performance of equity REITs can also be tracked through an equity REITs index.
Mortgage REITs
Mortgage REITs (mREIT) are an important part of the real estate industry; they provide capital to real estate investors looking to purchase properties by lending money directly or indirectly by way of structured mortgage-backed securities. The income for these companies is generated from the difference between mortgage interest gains and costs to finance those loans.
However, this means that it can be vulnerable to upward interest rate pressure. When considering exposure to it, investors must keep this in mind, ensuring that the risk-reward ratio is favorable.
Hybrid REITs
Hybrid REITs are an increasingly popular investment option that can provide investors with the best of both worlds. They utilize the strategies of both equity and mortgage REITs, allowing investors to benefit from two different ways of earning returns.
For instance, hybrid REITs can employ methods such as leveraging borrowed money to purchase properties or buying well-performing stocks and bonds in other industries.
It can offer investors access to dynamic markets while protecting their portfolios during market volatility. By combining the great potential for returns with a manageable level of risk, investing in this type of REIT is becoming more attractive than ever before.
Pros of REITs
Steady Source of Income
For those looking for a steady source of income and long-term capital appreciation, real estate investment trusts (REITs) are an attractive option. Their high payout rates stem from a tax structure that benefits companies that own and manage their real estate properties.
This arrangement provides a steady stream of cash flow to lighten up REIT's dividend burden and offer investors more competitive yields than many common equities do. As gross income becomes increasingly volatile, the potential return offered by these income-producing real estate (REITs) can be very attractive to some investors.
Increased Accessibility
REITs offer investors many benefits, including increased accessibility to otherwise hard-to-reach commercial and residential real estate assets and personalized investment advice. By investing in a portfolio of these income producing properties, investors can benefit from the diversification and liquidity that REITs offer.
Usually listed on major national exchanges and registered with the sec, these securities provide straightforward ways for investors to purchase commercial real estate without having to go through the more complex processes associated with purchasing such assets directly.
This is particularly beneficial for those who may not have access to the same resources available to bigger real estate investors. The increased accessibility and liquidity of REITs is part of what makes them so attractive to many high-net-worth individuals and institutions. Purchasing real estate through REITs gives individual investors access to commercial assets that would otherwise require advanced knowledge and skills to underwrite, purchase, and manage.
Diversification
Diversification should be an important component of any financial and investment portfolio. REITs, or real estate investment trusts, are a way to gain exposure to the real estate market with less risk than it would take to buy physical property.
REITs tend to have a longer time horizon than other markets, such as bonds or stocks; their cycles typically last a decade or more, compared with an average timeline of roughly 5.75 years for investments in traditional markets. They can provide an attractive way to diversify and achieve strong returns over the long term and receive larger dividends, especially compared to other investment funds. By giving you exposure to the real estate market, they can make a great addition to your portfolio and help smooth out the volatility of stocks, bonds, precious metals, and other investment vehicles.
Inflation hedging
Real estate investment trusts (REITs) offer investors a means of protecting their portfolios from the negative impact of inflation in the property sectors. With these investments, investors own portions of a trust that owns and operates commercial properties such as office parks, apartment buildings, retail spaces, industrial facilities, and so on.
The rent agreements associated with these properties are often written in a way that automatically adjusts for inflation. Thus, when inflation rates go up, rent payments increase accordingly; this helps REIT owners weather the negative impacts that come with rising costs due to inflation. Real estate, regardless of in a REIT or traditional real estate investment, has shown to be one of the best hedges against inflation of all time.
Cons
High Debt Burden
REITs come with an unusually high debt burden, creating a risky situation for investors who may find their dividends threatened. Fortunately, this debt is not without reason - REITs require a lot of upfront capital to acquire properties and often use that debt to finance these investments.
However, what sets publicly traded equity REITs apart from smaller real estate investments is their ability to secure long-term contracts like leases that guarantee the presence of cash flow over time. This periodic income helps buttress the payments for their heavy debt and ensures that regular dividends can still be paid out.
Limited Growth
When economic conditions are tumultuous, retail investors may not be as eager to purchase REITs' stocks and bonds listed on the stock exchange. As a result, the organization's capacity to accumulate and reinvest capital into real estate may be hindered due to a lack of financial resources.
This is particularly troublesome for those seeking opportunities that provide steady growth potential combined with fruitful capital appreciation—for these investors, waiting out an economic recession and seeking other investments while the REIT sector experiences low growth in the stock market can often be more advantageous than continuing to bear the ups and downs of this market.
Tax Load
The tax burden for real estate investment trust (REIT) investors is a maddeningly unfortunate reality. REIT companies receive a unique tax advantage; they do not have to pay corporate tax on taxable income from rent or sale of their property. REITs pay corporate income tax, and individual investors still have to pay taxes when they receive dividends from their REIT investments.
Unfortunately, the individual investors in these companies still must pay taxes when they receive dividends from their REIT investments, regardless of how it is held. This means that any gain an investor has made is unnecessarily diminished by having to pay the government in a situation when other investments are not required to do the same.
It is an inequity that remains frustratingly true and requires careful consideration before investing in this type of investment. An investment adviser can provide a comprehensive view of the real estate market and the place of REITs within it.
How to Invest in REITS?
Investing in REITs can be smart if you want to maximize your returns with passive income through investment strategies. Getting started is easy. Once you have a brokerage account (ie. E-Trade, Charles Schwab, etc) you can search for and buy publicly traded REITs just like you would any other stock.
To maximize your tax savings, consider investing in an IRA or similar tax-advantaged account so that you can delay taxes on the dividends you receive. Suppose you don't want to commit to researching REITs. In that case, many brokerages offer ETFs or mutual funds that invest in a range of REITs for you—offering immediate diversification and lowering risk. Either way, we recommend speaking with both your investment advisor and your financial advisor prior to getting started.
Investing in REITs can offer a great diversified investment portfolio, but it is important to consider the different types of REITs before purchasing. Buy publicly traded REIT shares through a brokerage account, or consider non-traded REIT's offering through a financial advisor to get started.
Such investments may tend to be relatively inexpensive, with most trading below $100 a share. To further diversify an investor's portfolio, focused mutual funds or exchange-traded funds (ETFs) can also be purchased. However, investing in public non-traded REITs through a financial advisor or real estate crowdfunding portal may be more time-consuming and challenging.
Conclusion
In conclusion, REITs offer a unique investment opportunity for many investors, focusing on various real estate property types. They have the potential to generate an income stream and also appreciation in value over long-term investments.
The key is researching the different REITs available such as publicly-traded REITs and private REITs, keeping track of your investments, and knowing when to buy and sell them on the market. Whether you are an investment professional or not, this type of investment does come with its own set of risks that help make it more attractive for higher returns and interest income. However, proper understanding and research of the industry can help mitigate these risks.
No matter your investing knowledge or experience level, it is important to become informed before beginning this type of investing. With great returns comes great responsibility to make sure that you are making sound decisions about your investments. Follow us for more updates about all things real estate - such as tips on how to invest smarter and insights into today's real estate markets!
