REIT Investing for Beginners: A Complete Guide

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Real estate investment trusts give investors exposure to the real estate market with no direct investment in a property. In fact, REITs were authorized by Congress in 1960 specifically to allow small investors to reap advantages usually available only to investors with larger resources. Today, 195 REITs, worth a combined $1.37 trillion, exist in the U.S., according to Statista. Many trade on the open market and are regulated by the U.S. Securities and Exchange Commission.

What Is a REIT?

A REIT is a company that owns investment properties, such as apartment buildings, office buildings, hotels, warehouses, storage facilities, healthcare facilities or shopping malls — and/or mortgages or other real estate debt. The company’s mission is twofold: generate income for investors in the form of dividends, and appreciate in value over time.

REITs that invest in investment properties are called equity REITs. Most equity REITs operate the properties they own.

REITs that invest in mortgages or other real estate-related debt are called mortgage REITs. Rather than purchase and operate property, mortgage REITs loan money for the purchase of real estate or invest in mortgage-backed securities, which are debts secured by mortgages. Mortgage-backed securities are an indirect way to make loans, so they, like mortgage loans, generate interest income for the REIT and its investors.

REITs have to follow strict rules in order to maintain their status. At least 75% of their assets must be invested in real estate or cash. Also, at least 75% of their gross income must come from real estate-related sources, such as rents from their properties and interest from any real estate-related debt they own.

What Is the 90% Rule for REITs?

The 90% rule says that REITs must distribute at least 90% of their taxable income each year to shareholders. The SEC notes that because dividends are tax-exempt for REITs, many actually pay out 100% to avoid paying corporate income tax.

Types of REIT

REITs come in three main varieties: publicly traded, non-traded, or non-exchange-traded, and private.

Publicly Traded REITs

Publicly traded REITs trade on stock exchanges — the New York Stock Exchange, primarily — just like stocks. And just like companies whose stocks trade on exchanges, REITs have to file reports and disclosures with the SEC.

Being listed on a stock exchange makes REITs easy to trade, meaning you’re likely to find shares available of the REITs you want to invest in, at the exact time you want to invest, and should be able to sell your shares quickly as well. What’s more, you can make the trade through the same brokerage account you use to trade stocks and bonds. The minimum investment is one share, at whatever the price happens to be when you purchase it. The largest U.S. REIT, Prologis, traded at about $109 per share on May 15.

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While REITs are not exchange-traded funds, publicly traded REITs have some features in common. For example, both measure their performance against specific benchmarks, which provides a way for you to evaluate their suitability for your portfolio. Two popular REIT benchmarks are the MSCI US REIT Index and the S&P United States REIT Index.

You can track publicly traded REIT share prices in real time whenever the markets are open.

Non-Traded REITs

Non-traded REITs also are subject to SEC rules and filing requirements, but they’re not listed on stock exchanges. While they avoid price volatility inherent in traded REITs, minimum investments are high — $1,000 to $2,500, according to the SEC — and share prices are based on the net value of the REIT’s assets. Unless you understand the underlying asset valuations, it can be difficult to evaluate the share price. Performance is also hard to gauge because it’s not measured against a benchmark.

You’ll also pay fees on non-traded REITs. Commissions and other up-front costs usually total 10% to 15% of the investment, according to the SEC, and you’ll likely pay ongoing management fees as well.

The fact that they’re not traded makes non-traded REITs potentially difficult to sell. You might have to wait a specified period, often several years, before redeeming your shares. You might actually be required to liquidate at that time. However, some REITs have purchase programs or secondary markets where you might be able to sell your shares early, albeit possibly for less than you paid.

Private REITs

Whereas public REITs are available to any investor, private REITs are geared toward institutional or accredited investors — those with at least $200,000 in annual income and a net worth of at least $1 million, according to the SEC. They’re the riskiest REITs to invest in because they’re not regulated by the SEC, and you can’t trade shares on an exchange.

Pros and Cons of REIT Investing

REITs are a unique investment with positive characteristics and some aspects that might make you think twice about investing.

Pros of Investing in REITs

Here are some reasons to consider adding a REIT to your portfolio:

• They’re an easy way to gain exposure to the real estate market.
• Shareholders receive at least 90% of a REIT’s taxable income in the form of dividends, which provide passive income.
• You can invest in publicly traded REITS from your regular brokerage account, for the price of a single share of the REIT of your choice.
• The SEC regulates all public REITs, traded and non-traded alike, which protects shareholders against fraud.

Cons of Investing in REITS

Consider these drawbacks before you invest:

• The dividends you receive are taxable in the year they’re paid.
• REITs that invest in a particular type of investment property lack diversity.
• Non-traded REITs often have high fees and lack share price transparency.
• High dividend yields might signify that dividends are being paid from borrowed funds or the proceeds of offerings rather than taxable income, especially with non-traded REITs.

Risk of Investing in REITs

All investments have some degree of risk. The following are some of the most significant risks of REIT investing for beginners.

• Liquidity risk: Shares in non-traded REITs have low liquidity. You might not be able to sell your shares, and even if you can, there’s no guarantee you’ll get what you paid.
• Interest rate risk: Interest rates can have a profound effect on the real estate market, which impacts the value of a REIT’s holdings.
• Business risk: A REIT’s performance is highly dependent on the strength of the companies that lease its properties. If its tenants falter, the REIT might struggle to remain profitable.
• Income risk: Despite the 90% rule, there’s no guarantee that you’ll receive dividends from a non-traded REIT.
• Conflicts of interest: Most non-traded REITs and some publicly traded REITs hire outside managers to manage their assets and operations. As the SEC warns, these managers are sometimes paid according to the amount of property they acquire and manage, which can result in managers acting in their own interest instead of the interests of shareholders. In addition, outside managers might also work for companies that compete with your REIT.

REIT Investing Strategies

It’s important to keep your investing goals and your risk tolerance in mind as you develop a strategy for investing in REITs.

For example, if you’re risk-averse, you might spread your investment dollars across several REITs to incorporate different types of investment property, and perhaps add mortgage REITs into your equity REIT mix. Alternatively, you might invest in a mutual fund or exchange-traded fund that invests in many different REITs, or that tracks a REIT index, instead of picking and choosing REITs on your own.

If your goal is to minimize tax liability, you might use a tax-deferred retirement account, such as an individual retirement account, to invest in REITs. That way, your dividends and capital gains are tax-deferred.

When the goal is to create a regular source of income, a good strategy is to focus on traded REITs. There’s no guarantee of dividends from non-traded REITs, which can affect your income in the short term. Long-term income could suffer if the non-traded REIT pays dividends from borrowed funds or offerings, which siphons value from your shares and leaves less money for the REIT to invest.

How Do REITs Compare To Other Investments?

Experts recommend building an investment portfolio with a diverse range of assets, but deciding which to invest in is difficult if you’re not sure of their similarities and differences. Here’s a look at how traded REITs stack up against ETFs, mutual funds, stocks and bonds.

Is Investing in a REIT a Good Idea?

Investing in a REIT could be a good idea for the right investor. If you want to diversify your portfolio with real estate investments, a REIT can be a lower-risk, more cost-effective alternative to buying and managing property. However, REITs are meant to be long-term investments. You should be prepared to hold your traded shares for at least a few years, and you might need to hold non-traded shares for a decade or more.

Information is accurate as of May 16, 2024. 

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