What Is a REIT?
Created in 1960, according to REIT.com, President Eisenhower opted to define REIT laws to give all investors access to large-scale investment opportunities in real estate. Since then, the REIT definition has grown and evolved, but the idea has stayed the same.
REIT stands for “real estate investment trust.”Vanguard describes these trusts as companies that purchase properties that will create an income stream. Individuals can then invest in the REIT, often resulting in high dividend yields if the real estate market is successful.
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The real estate investment trust definition is often compared to the definition of a mutual fund. Both involve bringing together many different investors who pool their money and invest together, in hopes of the entire group making a profit. A management team takes care of investing the money and managing the property while the REIT definition makes them a source of passive income for investors.
Types of Real Estate Investments
The REIT definition includes any properties that generate an income for those who have invested. These properties can be divided into five categories of types of real estate investments which include equity and mortgage REITs.
- Retail
- Residential
- Health
- Office
- Mortgage
Retail REITs
According to Investopedia, shopping malls and freestanding shopping centers account for 24% of REIT investments. For retail properties, investors make money from the rent collected from tenants. When the retail industry is doing well and spaces within shopping centers are full, investors have the potential to earn high profits.
Unfortunately, when the economy is suffering, the retail industry is hit hard. An article from Seeking Alpha discusses the declining profit of the retail industry and points out that an increase in online sales may also be to blame. What is a real estate investment solution? Seeking Alpha suggests finding space for services, like gyms and dry cleaners, that can’t be taken over by online counterparts.
Residential REITs
While owning property and becoming a landlord is a path that many people take, it isn’t the only way to own rental properties. The REITs definition includes any properties that generate an income. For the residential category, that usually means apartment buildings.
Home improvement and house flipping television shows have given many people the impression that making money through residential investments is easy. However, if the demand isn’t there, a property can easily be left vacant, which means a lack of income for owners. What is an REIT property that will actually make you money? Investopedia outlines what to look for then choosing a property.
- The right timing:While you may be ready to jump into an investment, keep an eye on the real estate market to determine whether interest in rentals in the area is increasing or decreasing.
- Location:Obviously, purchasing property in an area where more people are leaving than moving in and unemployment rates are rising won’t make for a great investment. Look for property in areas where the demand for apartment housing is high and supply is low.
- Predict urban sprawl:After nailing down a city, be deliberate with the area you choose to invest your money and time in. The best properties will often be found on the perimeter of a bustling city, in an area that is on the verge of being built up into the next trendy location.
Health REITs
What is a real estate investment trust option in the health field? The category ranges from hospitals to smaller medical centers and also includes retirement homes and extended care facilities. As The Motley Fool points out, the healthcare industry is continuing to grow, making investing in this category of REITs a smart choice.
In addition to the growing industry, there are a few other factors that make health REITs a strong option. First, medical centers involved in the investments tend to be in more affluent locations. The properties also tend to be run by large, well-established mangers that offer many investors a feeling of security.
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Office REITs
The office REIT definition is exactly as it sounds. Those involved in the trust are investing in office buildings. Income comes from the companies who become tenants and pay rent for their office space. As with real estate properties, choosing a good office building investment should involve finding a prosperous location where the demand for space is high.
Mortgage REITs
While the previous categories are all considered equity REITs, investors can also choose mortgage REITs. The mortgage REITs definition involves investors giving money directly to a landlord who makes the property purchase. The investors then receive income that comes from the interest on the loan to the landlord. Market Realist further describes the difference between equity REITs and mortgage REITs.
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What Are REITs Benefits?
Since mutual funds and REITs are so closely related, the benefits are similar as well. Investopedia explains that the major benefit of these group investment opportunities is the power of the group. Making a huge real estate purchase alone would be difficult financially, but doing so with a large group makes it less of a strain and less of a risk.
According to Wealth Daily, the financial benefits that define REIT options far outweigh the risks. The article points out that if you choose the right property, long-term leases with reliable tenants can create a stable, passive income stream.
That passive income is a huge draw for many investors. As The Motley Fool explains, investors can purchase shares of an REIT, then sit back and wait for the income from the property, without any hands-on work. The REIT management team will take care of the work. What is an REIT management team? It’s the group of professionals and trustees that manage the property on behalf of the investors. It doesn’t get much easier.
The REITs definition means that individuals purchase shares rather than purchasing the property outright. This means that REITs are liquid, making them much easier to deal with than buying and selling property. Purchasing shares for multiple properties and property types can offer a diversified portfolio. Going to the management company website can give you a quick and easy look at how your investment is doing.
Why is diversification important and what is a REIT role in diversifying? REIT.com describes how diversification can help to build up savings for a more comfortable retirement. Investing in REITs can help to offer long-term returns by getting involved in a new area outside of standard stocks and bonds.
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What Are REITs Risks?
While many individuals are quick to jump at an opportunity to add real estate to their investment portfolio, REITs come with their own set of drawbacks. It’s important to define REIT risks as well as the benefits.
Personal Capital outlines many of the potential risks involved with investing in real estate. First, those involved in the REIT will need to assume responsibility for the property. This means finding tenants, maintaining the property, and taking care of everyday issues will be the responsibility of the owners. Obviously, in most cases, a property manager could be hired, but that additional cost is a consideration that shouldn’t be overlooked.
When continuing to define REIT extra costs, taxes come into play as well. According to Personal Capital, 90% of REIT income is returned to investors through dividends each year. Each person then needs to account for that income on their personal taxes. How to handle that income and the resulting taxes, in a way that makes financial sense, is another important factor to consider.
When determining risk, many will ask the question, “What is a real estate investment trust risk as compared to stocks?”Zacks compares the two. The article mentions that both are high-risk investments that can fluctuate quickly, based on how the market is performing from one day to the next. However, the real estate market focuses mainly on property values while stocks are affected by many different factors.
How to Form and Invest in an REIT
The rules, requirements, and guidelines for forming an REIT can be complicated and difficult to understand. REIT.com outlines these guidelines to define REIT requirements and discuss how companies can work through the process. While the rules and regulations are complex, there are several basic requirements, including the following.
- The REIT must be formed in one of the fifty states or the District of Columbia as a corporation.
- The REITs definition specifies that there must be at least 100 shareholders and that five or fewer of those shareholders cannot own 50% or more of the value.
- 75% or more of the REIT annual income must come from rent or other real estate-related sources. 20% must also come from those sources or from dividends and interest. Only 5% or less of the income can come from non-qualifying sources.
- At least 90% of annual taxable income must be distributed. Taxes must be paid on that income.
Due to the complexity of the process and the amount of money involved, it’s important to choose a reliable team to work with. What is an REIT management team’s role? The group will consist of investment experts, lawyers, and accountants who will ensure that the best investments are chosen. There are many of these management teams, both large and small, already set up and ready to help individuals begin investing.
After determining which of the types of real estate investments you’d like to take part in, you can choose how you’ll invest. REIT.com offers helpful criteria for determining which REITs to choose. The criteria include characteristics like a reliable ability to generate income, a management team that can reliably invest money to create revenue, and a clear strategy for growth.
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Should You Invest in an REIT?
A 2015 article from CNBC warns investors of the pitfalls of the unsteady real estate market and the toll it takes on real estate investments. The author notes that the shaky economy affects each of the areas that define REIT investments differently. For example, retail spaces tend to remain empty when there is less of a demand for consumer goods, but apartment buildings tend to become more in demand as more people opt to rent rather than buying homes when the economy is suffering.
While the CNBC article may be skeptical, another article from Forbes takes the opposite stance. The article points out that property will continue to be in demand as more people choose renting in an effort to avoid the high costs of home ownership.
Finally, Personal Capital looks at the balance between risk and reward when asking the question,“Are REITs a good investment?” As with any investment opportunity, REITs offer the potential to make or lose money, based on many different factors. If you’re willing to take the risk, adding one of the types of real estate investments to your portfolio can be a great long-term decision.
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