Many people have been asking me lately, “Should I invest in a REIT?” Some people seem to think they’re the best thing since sliced bread, while others deem the proposition too risky with the current rising interest rates. If you’ve been asking the same question, read on—we’ll walk you through whether or not you should invest in a real estate investment trust.
What is a REIT?
First things first, we’ll discuss what a REIT is. Here’s the official definition, according to the National Association of Real Estate Investment Trusts:
A REIT, or Real Estate Investment Trust, is a company that owns or finances income-producing real estate. Modeled after mutual funds, REITs provide investors of all types regular income streams, diversification and long-term capital appreciation. REITs typically pay out all of their taxable income as dividends to shareholders. In turn, shareholders pay the income taxes on those dividends (NAREIT).
A company has to make a tax election and follow certain requirements to qualify as a REIT. Its assets need to be primarily real estate, and most of its income must be derived from real estate. According to the IRS, there are approximately 1,100 REITs in the United States. There are REIT-owned properties in every state in the nation, and REIT companies are expanding past U.S. borders and spreading around the world. REITs are also present in a huge variety of industries. NAREIT writes, “Today, REITs are tied to almost all aspects of the economy, including apartments, hospitals, hotels, industrial facilities, infrastructure, nursing homes, offices, shopping malls, storage centers, student housing, and timberlands” (Source).
What are the Benefits of a REIT?
There are a number of benefits that make it a potentially smart move to invest in REITs.
Invest in smaller amounts: When you think about real estate investing, you probably imagine buying a condo, single family home, or maybe a commercial space. Any of these are a huge investment, and a huge risk! REITs allow you to still collect benefits without dropping tens of thousands of dollars into one property.
Go debt free: Chances are, you’re just an average person with an average income. Like the vast majority of people, you probably can’t afford to purchase an entire property upfront. That means it’s necessary to go through all the steps to get approved for a mortgage, and then pay it off slowly. Some people are OK with this, but others prefer to go debt free. A REIT can help you do that, because you can basically invest as little as you like. A couple thousand is much easier to do than tens of thousands.
Collect income without a lot of work: Most of the work involved is upfront. You will have to do your research and take the time to find a REIT that works for you and your needs. But once you’ve purchased the units, you can basically sit back and relax! No need to manage your own property or worry about whether your property manager is doing their job. Once the property starts making money, you will get monthly distributions straight to your account with very little work on your part.
Expert managers: Chances are, you’re not an expert at managing properties. Or maybe you know quite a bit but just don’t have enough time. In either case, REITs are a great option, because they have management teams with industry experience, business management skills, and more. You can leave it to them to handle the day-to-day work of managing properties, while you focus on your own job.
Take advantage of liquidity: Generally, REITs are quite liquid. If you decide to sell, it should be a quick process—often just a day or so. It’s a lot like trading stocks, and it requires very little time and expertise. That’s a huge difference from owning your own property—how many people can say that their home or commercial space sold in less than a day, without the help of a professional, and with minimal investment of time and money?
Diversify immediately: There are several different classes of REITs, so you can take advantage of this by buying set amounts in different classes for immediate diversification. You can utilize separate REITs for each asset of you want.
What are the Drawbacks of REITs?
Just like any type of investing, REITs do have their disadvantages.
REITs can be risky due to the cyclical nature of real estate: Many people think that real estate investment trusts will provide them consistent dividends, but this isn’t always the case. REITs don’t necessarily provide a guaranteed income stream, because downturns in the market can make them unstable. Different REITs might survive economic downturns better than others, but it can be hard to predict.
REITs grow slowly: Most Wall Street companies are able to invest their profits back into their busiensses at a high rate, but REITs can only reinvest a maximum of 10% of their annual profits, so they grow at a slower pace in general.
Most REITs are taxed at higher ordinary income rates: REITs do not have to pay tax at a corporate level, but their shareholders have to pay tax on the income they receive. If you are in a high tax bracket, you might be looking at some fairly significant taxes.
It isn’t always easy to diversify: While it is possible to diversify your portfolio with REIT investing, you have to choose carefully. Most REITs specialize in a single property type. If something goes wrong in that segment of real estate, it could prove disastrous for your portfolio. Keep this in mind when you are buying REITs, and make sure to invest in more than one segment.
The Bottom Line
The bottom line is that it’s really up to you! I think investing in REITs is generally an excellent idea, provided that you’re aware of the drawbacks and do what you can to overcome them. As with anything, you will need to do your research and figure out what works best for your unique needs.