An REIT, or Real Estate Investment Trust, is a real estate company that you can invest in to receive dividends from their profits. There are a lot of REITs that cover a wide variety of real estate industries. They can investors easy access to property and even rental investments, especially for those that can't afford to purchase an entire building or manage their own properties.
You may be interested in the income benefits of being a landlord but lack the start-up capital or credit to purchase an entire property. Some people can afford a property but don't want to actually manage it. REITs give you a way to tap into this industry solely as an investor, while the company handles all of the actual work needed to generate the profits. This can be a powerful addition to your investment portfolio, so I'm going to give you a crash course on Real Estate Investment Trusts.
What are REITs?
A Real Estate Investment Trust is a special type of regulated company that focuses on real estate. In fact, they're legally required to invest 75% of their funds in real estate. In general, each separate company will have their own specialization. Some of them may only invest in residential real estate or apartment buildings for the rental market. Others will focus on commercial real estate like office space, retail shopping centers, hotels and more.
Just like a landlord would do, these companies will buy properties and lease them to individuals or other businesses. Their profits come from the rental funds that are collected from those tenants. With most REITs, you're basically investing in rental property and becoming a landlord. The big different between this and actually being a landlord is you don't have to do any work. No finding tenants, performing maintenance or worrying about evictions either.
Most downsides that come along with being a landlord are erased by investing in an REIT instead. You get to be a silent partner and simply collect a check for your share of the profits. These profits are paid out via dividends, often monthly or quarterly. Your initial investment capital can even grow long-term as the properties appreciate in value. This long-term appreciation in addition to high dividend payments are among the biggest reasons why this is an attractive investment option.
Portfolio Diversification Benefits
Portfolio managers used to have it pretty easy when they wanted to diversify someone's investments. In recent years, many asset values have become highly correlated. When one of them plummets in value, so do the others. This makes it really hard to protect a portfolio from significant losses since there aren't many good options that will hold value in the face of a market crash.
REITs are considered to be one of the few investments these days that can actually help diversify a portfolio though. Their values and profits usually do not rise and fall with the fluctuations of stock markets and other assets. This low correlation combined with pretty steady dividend payments makes them a great choice for a wide variety of investment strategies.
Anyone looking to generate a passive income from their investments should definitely consider REITs. They're popular for retirement portfolios to generate a monthly income that can be used to live on without drawing down the initial investment capital.
Historically, REITs average about the same returns as investments in the stock market. There are periods where one outperforms the other in the short-term though. More recently, the S&P500 performed better. For investments made 20 years ago and held until today, REITs have beat the S&P500, although not by a large amount.
13 Types of REITs
No matter what kind of real estate you want to invest in, you can probably find an REIT that will match your goals. There are actually 13 different industry sectors covered by these companies. Within those 13 sectors, companies will often specialize in a specific subsector too. That means if you want to invest in a company that buys and rents office space to the government, you can do that to laser focus your portfolio.
The 13 main sectors of REITs are: Residential, Office, Health Care, Industrial, Retail, Self-Storage, Lodging, Data Centers, Infrastructure, Mortgage, Specialty, Diversified and Timberlands. As you can see from this list, there are a really wide range of industries that you can target with these investments, and these are just the main categories.
The vast majority of these REIT sectors will purchase properties to lease them out to tenants to generate revenue. The one main exception is the Mortgage sector. This is a financing based sector that earns revenue from interest and not collecting rent.
In general, I would recommend sticking to public, listed REITs. These companies will be registered with the SEC, so they'll have to follow their strict regulations for this industry. The public companies are liquid assets you can trade on a stock exchange.
The SEC has a list of requirements for a company to qualify as a Real Estate Investment Trust. These regulations are meant to ensure that these are high-quality companies that engage in business in the industry that they claim. For example, 75% or more of all assets for the business have to be invested in real estate, so they can't diversify too much into other industries.
Income and profits are regulated for these companies too. 75% of gross income has to come from rental payments, financing interest or real estate sales. 90% of profits have to be paid out as dividends to shareholders. These percentages are minimums too. Many companies do even better than the minimums. This is important for investors to ensure that they're invested in the right industry. It also helps to ensure that they actually get paid for their investment in the form of a share of the company profits.
Buying a House vs REITs
You're considering an investment in real estate, but you don't know whether it would be better to buy a house or invest in REITs. A lot of people without knowledge of these companies will immediately think that buying a house yourself would be a better investment. However, this may not necessarily be the case.
When you buy a house, you're concentrating your investment into a single asset. If residential homes in the area drop in price, your investment can take a big hit. An REIT actually gives diversification in your real estate investment though.
Even if you put all of your money into a single Real Estate Investment Trust that specializes in buying and renting houses, you still end up with much more diversification compared with buying a single home. The company will have investments in many different homes throughout the country, so they'll be less vulnerable to a market downturn. However, you don't have to invest in a single company either. You can spread it out over a variety of different industries to hedge against losses in one sector.