REIT Investments: Yea or Nay?
When it comes to investing in real estate, there are a variety of niches and methods. And in some cases, you don’t even need to be the direct owner of a piece of real estate in order to benefit from it. Real estate investment trusts, or REITs, would be a good example. But are they smart investments for the average investor’s portfolio? Let’s dive in and take a closer look:
What is a REIT?
“A real estate investment trust, or REIT, is a company that owns, operates, or finances income-producing real estate,” property management company Green Residential explains. “This is typically done by pooling investors’ money together to buy and manage commercial and/or residential buildings. The company then collects money from tenants and passes the profits on to investors.”
The REIT is essentially a “landlord” with a portfolio of properties. Each shareholder in the REIT provides money to finance and manage these properties. The profits are then distributed among the shareholders for (hopefully) a profit.
You can divide most REITs up into one of two categories. The first category consists of equity REITs (eREITs). These are the most common. They own and operate income producing real estate – either residential, commercial, or industrial. They tend to focus on a single type of property and benefit from formulaic methods of investing.
The second category consists of mortgage REITs (mREITs). These provide liquidity for the real estate market by investing in both residential and commercial mortgages. They may also invest in residential mortgage-backed securities or commercial mortgage-backed securities.
The Advantages of REIT Investing
REITs – whether eREITs or mREITs – are attractive to investors for a variety of reasons. Here are a few of the biggest advantages:
- By law, REITs are required to pay out at least 90 percentof their income as dividends to investors. The managers of the trust can increase the payout to a higher percentage, but are never allowed to go below this threshold. As a result, investors don’t have to worry about a fund manager running off with most of the earnings.
- Hands-off. As opposed to being a direct landlord or real estate investor, REITs require zero effort from investors. There’s no mowing lawns, fixing leaky toilets, or dealing with tenants who don’t pay on time.
- Highly liquid. Unlike most real estate investments where it takes weeks or months to facilitate a transaction, REITs are highly liquid. You can buy and sell shares in real time.
- An REIT is a nice investment to have when you’re trying to diversify your portfolio away from traditional stocks and bonds. It also allows you to spread your money out across multiple pieces of real estate, as opposed to putting it al in a single property that could go down in value.
The Drawbacks of REITs
As advantageous as REITs can be, they aren’t perfect investments. There are a few potential drawbacks and risks, including:
- Limited growth potential. Unfortunately, the 90-percent required dividend payout is a double-edged sword. This means REITs have 10 percent or less to contribute towards improving or adding properties. As a result, there isn’t always a ton of growth.
- Tax disadvantages. REIT dividends don’t always qualify for 15-percent tax rates like other investments. Many are taxed as ordinary income, which can be costly for investors in higher tax brackets. This means a single filer with an average income would pay more like 22 percent on the earnings. (On the other hand, a low income individual may be able to pay as little as 10 percent.)
- Lack of control. When you own a piece of real estate in your name, you have the ability to call the shots. When you’re merely an investor in an REIT, you don’t have much say over when properties are bought, sold, updated, etc. If the REIT isn’t making smart choices, it can be frustrating to watch and not be able to do anything.
Diversify Your Real Estate Portfolio
As a real estate investor, it’s wise to diversify your portfolio. Not only should you spread your money out across multiple properties, but it’s also smart to utilize different methods of investing. REITs are just one way you can switch things up. Do some additional research and see if your portfolio has room for a real estate investment trust.