What is a Real Estate Investment Trust (REIT)?

While there are many different types of investments that you can make when attempting to improve your portfolio, among the most popular investment options in recent years involves real estate investing. Investing in real estate can involve anything from buying a rental property to purchasing an undervalued property before fixing it and selling it for more money.

Even though it’s common for investors to place their money directly into a property, it’s also possible to invest in trust funds, which are held by third parties and usually involve numerous investors. There are several methods you can use to gain returns from a real estate investment. If you purchase a rental property, you could then earn income from the monthly payments you receive from tenants. Because real estate values have been consistently increasing over the past decade, there’s also a good chance that the value of your property will rise while you own it, which can help you maximize your returns.

It’s highly recommended that you get involved with real estate investing if you want to make relatively low-risk investments that can generate predictable and steady returns. Many investors use real estate investments to balance a riskier investment portfolio, which can pay dividends in mitigating losses from a poor investment. There are many different types of real estate investments that you can make, the primary of which include crowdfunding, REITs, commercial real estate, residential real estate, and raw land.

The type of investment that works best for you largely depends on the kind of investor you want to be and the amount of risk that’s acceptable for you. If you want to invest in real estate without the hassle that comes with owning, financing, or operating a property, you can invest in a real estate investment trust.

REITs are typically managed by investment companies that use money from numerous investors to buy, manage, and sell properties that are able to produce income. Because these properties generate consistent income, you’ll receive regular payments after making an investment. The following takes a closer and more detailed look at real estate investment trusts and how they can benefit all kinds of investors.

Different Types of REITs

In the event that you want to invest in a REIT, there are four separate types of REITs that you can invest in. Each type has its own benefits and can help you diversify your portfolio.

Equity REITs

An equity REIT is the most common type of REIT that you can invest in. This type of trust involves owning and operating properties that can generate income. Any property that’s leased directly to tenants would be referred to as an equity REIT. These properties include shopping centers, office buildings, and apartment complexes. As touched upon previously, it’s possible to generate revenues with an equity REIT in two ways.

The first method is by obtaining monthly rent payments from tenants, which are then distributed to every individual who invested in the REIT. These returns are provided to you as dividends. Equity REIT dividends are usually reliable as a result of consistent rent payments and property value appreciation. This type of REIT is considered to be a long-term investment.

MREITs

An mREIT is a mortgage REIT that allows investors to obtain financing for income-generating properties. To obtain this type of investment, investors would purchase mortgage-backed securities or originating mortgages on properties that they’re interested in. Revenues are then generated from the overall interest in the investments. Shares of mREITs are listed on all major stock exchanges. You can also purchase an mREIT in the form of an exchange-traded fund or a mutual fund.

An mREIT fund relies on a wide variety of different sources, which include everything from structured financing to preferred equity. The main risk that comes with investing in an mREIT is that you will need to manage interest rate changes to make sure that your returns are where you want them to be. When interest rates drop, your returns could drop as well.

Public Non-Listed REITs

A public non-listed REIT involves any type of REIT that’s registered with the U.S. Securities and Exchange Commission but is not traded on major stock exchanges. This type of REIT works just like an equity REIT with the primary difference being that a public non-listed REIT comes with redemption restrictions. These restrictions are put in place to limit the number of liquid assets that are available through the REIT.

The minimum investment for a public non-listed REIT is typically around $1,000-$2,500. Any liquid assets you gain access to after making this type of investment will come in the form of secondary marketplace transactions or share repurchase programs. Keep in mind that nearly 90% of all taxable income that’s generated from PNLR properties must be provided to investors. Once you join a public non-listed REIT, you may not always know what properties are being invested in by the company or individual who is managing the trust. However, your returns will usually come from rental income.

Private REIT

A private REIT is a special type of REIT that doesn’t need to be registered with the SEC and isn’t listed on major stock exchanges. The main benefit of investing in this type of REIT is that quarterly and annual financial reports don’t need to be provided to the SEC. These types of REITs can typically only be sold to institutional investors, which are organizations or companies that invest funds provided by individual investors.

Your access to liquid assets with this type of investment depends on the company that’s managing the trust. Share redemption programs can be non-existent or limited in nature. As such, it’s important to obtain as much information as you can about the company that manages the trust before making this kind of investment. Since private REITs are usually only sold to institutional investors, the minimum number of investors can be as high as $25,000. The main benefits of investing in a private REIT include high-dividend yields and the ability to avoid regular market fluctuations.

Why Should You Invest in REITs?

There are many reasons why you should consider investing in REITs, the primary of which is that dividend income is typically high and consistent. It’s common for an REIT to generate annual returns that range from 6-8%. Another clear benefit of making this kind of investment is long-term capital appreciation.

As touched upon previously, the real estate market throughout the U.S. has been strong for well over a decade. Most areas throughout the country have seen consistent increases in property values. Whether you invest in an apartment complex or commercial building, the property values should rise over time, which will add to your returns.

If you decide to invest in company stocks as opposed to real estate, returns could be significantly higher. However, stock values can plummet in an instant and with hardly any forewarning. Even though the majority of REITs are listed on the stock market, you are able to avoid the high volatility that comes with standard stock investments.

Another top benefit of investing in a REIT is that the primary REIT holder must provide at least 90% of all taxable income to the shareholders. In fact, some REITs will provide 100% of taxable income. Once you receive this income, all you’re required to do is pay taxes on the income.

In general, a REIT investment is simple to manage since the majority of the management will be done by a third party. If a REIT invests in an apartment complex, the REIT holder will be tasked with managing the property, obtaining monthly payments, and making sure that the property is well-maintained. As a REIT shareholder, you’ll be able to receive returns without needing to manage any facet of your investment.

If you want to invest in an REIT but are unsure of how to do so, brokerage companies can look at your current financial objectives and help you identify potential REIT investments that would fit well in your portfolio. It’s highly recommended that you seek assistance from a brokerage company to avoid making mistakes when determining which REIT to invest in.

How to Analyze REITs

Any smart investment decision is backed up by extensive research and analysis. A REIT is essentially a dividend-paying stock, which means that you should have a good idea of how to analyze a REIT if you’ve invested in stocks before. However, there are some clear differences in the accounting aspect of a REIT when compared to stocks. When performing accounting with a REIT, you will be tasked with charging depreciation against the primary asset. If you purchase a commercial building for $1 million, the annual depreciation could be around $50,000.

This amount would need to be added to your balance sheet every year. Even though property depreciation needs to be included when analyzing a REIT, it’s unlikely that the property would depreciate in value by $50,000 every year, which means that your calculations likely wouldn’t be correct. However, they are safe calculations that take the potential risk of this investment into account, which is important for making sure that your investment decision isn’t a bad one.

The two forms of analysis for a REIT include a top-down analysis and a bottom-up analysis. When you perform a top-down analysis, this means that you will first focus on the greater economy when assessing a potential REIT investment. On the other hand, a bottom-up analysis begins by analyzing the property that you’re investing in. If you use a top-down analysis, the REIT could be affected by any economic factor that dictates the supply and demand of real estate. Job growth and population increases usually indicate that a REIT is wise to invest in.

Keep in mind that this type of investment is typically used as an inflation-hedging investment. Inflation occurs when the value of goods increases throughout the country. While stock values typically decrease when inflation increases, this isn’t usually the case with real estate investments. If you invest in a rental property of any kind, rent prices usually go up when inflation hits, which means that your returns will be higher. If you want to balance your portfolio, a REIT can be a great investment opportunity.