Owning real estate could be the oldest form of investing, but the costs and risks of holding real estate might be a poor fit for you. Luckily, real estate investment trusts, more commonly known as REITs, can provide you with most of the pros of real estate investing with very few of the cons.
What Is a REIT?
A real estate investment trust is a company that owns, operates or finances real estate. REITs make long-term investments by owning and leasing physical real estate or by purchasing mortgages or loans used to finance real estate. They aim to provide their investors with a steady stream of dividend income plus modest share price appreciation.
The focus on providing dividend income is a result of the special tax treatment REITs enjoy: As long as they pay out at least 90% of their taxable income to investors, REITs owe no corporate tax.
This doesn’t mean you get off tax-free, though. You pay ordinary income taxes on REIT dividends—most other stock dividends are taxed at a lower, preferential rate. You also may end up owing taxes on more than just dividends if assets inside the REIT are sold and the REIT realizes capital gains.
Public REITs vs Private REITs
REITs may be either public or private companies, though most real estate investment trusts are publicly owned. Transparency and liquidity separate public and private REITs.
- Public REITs are listed on a stock exchange and are relatively liquid investments—you can easily buy and sell their shares. They offer great transparency because they must register with the Securities and Exchange Commission (SEC) and disclose information on their holdings and activities. There are more than 200 publicly traded real estate investment trusts, many of which are listed on the New York Stock Exchange (NYSE).
- Public non-traded REITs are much less liquid investments, because they aren’t traded on major stock exchanges and may have requirements that you hold shares for a minimum period of time before selling. Management may buy back your shares from time to time, or you might be able to sell shares on a secondary market. While they’re less liquid, they offer good transparency because they also must register with the SEC and disclose quarterly and annual financial reports.
- Private REITs are relatively illiquid and don’t have to register with the SEC. This means you may have a hard time accessing the money you invest in the short term, and you may not fully be aware of what the fund invests in. Private REITs typically come with higher fees and don’t have to publicly disclose much information. Average investors generally can’t buy into private REITs, which only available to investment companies and accredited investors .
In addition to individual REITs, you can invest in REIT exchange-traded funds (ETFs) and REIT mutual funds, many of which are publicly traded and available for purchase at major brokerages.
Types of REIT Stocks
Broadly speaking, you can divide REITs into three types:
- Equity REITs own real estate, collect rent and manage the upkeep and other tasks that come with property ownership. Equity REITs may specialize in retail, healthcare, office or residential property. When you buy shares of an equity REIT, you’re buying a share of the REIT’s real estate holdings.
- Mortgage REITs originate mortgages, buy mortgages from banks and financial services firms or invest in mortgage-backed securities (MBS). Since debt always involves the risk a borrower might default, many mortgage REITs are considered higher-risk than equity REITs. Mortgage REITs may focus on residential or commercial property.
- Hybrid REITs own a combination of both mortgage assets and real property. A hybrid REIT can provide your portfolio with even greater diversification.
When investing in REITs, make sure you understand what type of assets they hold and whether their approach is aligned with your investment strategy and the amount of risk you want to take on.
How to Invest in Public REITs
It’s easy to buy listed public REITs, or mutual funds and ETFs that invest in REITs using an online brokerage account. Shares of REIT mutual funds may also be available to purchase in your employer-sponsored retirement account.
Your brokerage offers screener tools to help you evaluate the historical performance, returns and dividends generated by REITs. Researching a REIT’s management team is also important. Since a REIT is composed of a managed pool of assets, assessing the managers’ track record is key to understanding if a REIT is a good buy and if its management team is worth its fees.
Publicly traded REITs may have minimum purchases as low as the price of one share. If fractional share investing is available, this minimum may fall to $5 or less, making publicly traded REITs accessible to most any investor. Notably, publicly traded REITs can be bought and sold whenever an exchange is open, making it easy to access the cash value of your investment at almost any time.
How to Invest in Public Non-Traded REITs
Buying shares of unlisted public REITs is more challenging. Because they aren’t traded on an exchange, it may be more difficult to find public non-traded REITs on your online brokerage’s trading platform. Instead, you may need to purchase them directly from the REIT company itself or a third-party broker-dealer firm. Although anyone may invest, public non-traded REITs typically have a minimum investment requirement of $1,000 to $2,500.
Crowdfunding real estate investing platforms like the DiversyFund, Fundrise and Realty Mogul offer another way to invest in public unlisted REITs. These platforms generally require investors to commit to real estate investments for longer periods of time, however. This can be up to five years or more in many cases.
How to Invest in Private REITs
Investing in private REITs can be a risky, expensive proposition. Minimum purchase amounts can run as high as $25,000 or more, which is why they’re generally only available to accredited investors.
Private REITs are sold via broker-dealers or may be investment options offered to well-heeled investors by their wealth managers. They are highly illiquid, meaning you may only be able to sell a portion of your holdings at certain times each year, and they may charge high annual management fees in addition to various sales fees.
Because private REITs don’t have to register with the SEC, there’s often little to no data available for tracking the performance or even holdings of private REITs. This makes them particularly risky for investors with limited financial means or risk tolerance.
Should You Buy REITs?
For investors who want to add real estate exposure to their portfolios, buying shares of a publicly traded real estate investment trust can make a lot of sense. Just keep in mind that they may be better suited for dividend investing rather than growth investing, as share prices themselves may not change much over the long term.
Because they see much of their value growth through more highly taxed dividend income, REITs may be a great choice for your tax-advantaged investment accounts, like individual retirement accounts (IRAs), 401(k)s or health savings accounts (HSAs), that aren’t subject to capital gains taxes.