REITs and REIT ETFs offer investors a way of investing in real estate without buying property directly. These products can add diversification to an overall portfolio and lead to impressive long-term returns. REITs also offer tax advantages, making them a popular choice for income investors.
In this article, you’ll get an overview as to what REITs and REIT ETFs are. We will also look at the advantages and disadvantages involved with investing in them. You’ll learn how to invest in REITs and where to find further information and guidance on this topic.
What are REITs and REIT ETFs?
REIT stands for Real Estate Investment Trust. REITs are companies that own/finance commercial (income-producing) real estate. They are similar to stocks, representing the shares of a real estate company. A REIT can only be formed with at least 100 shareholders. There are around 1100 REITs in the U.S., including some massive players, such as Vanguard and Charles Schwab.
REITs are a liquid investment, and they provide the income potential typically associated with real estate. REITs can avoid paying income taxes if they comply with specific regulations. They need to distribute at least 90% of their profits to their investors as dividends, which is fantastic news for investors.
REIT ETFs, on the other hand, is a large basket of these securities. ETF stands for Exchange Traded Fund; this is a fund that issues shares which are then traded on a stock exchange. Several ETFs will passively track an index.
A REIT ETF may follow the performance of an index in the broader real estate market. REIT ETFs provide a highly liquid, low-cost way of investing in the real estate asset class.
Types of REITs
There are two main types of REITs: equity REITs and mortgage REITs. Each has a place in a diversified investment portfolio. Equity REITs own, operate, buy, and sell various types of real estate, including office spaces, retail and industrial buildings, hotels, residential apartment blocks, self-storage units, student housing, and more.
Mortgage REITs generate income from interest earned on money loaned to property owners. Mortgage REITs invest in both residential and commercial mortgages and mortgage-backed securities.
Who might want to invest in a REIT or REIT ETF?
More than 80 million Americans are currently investing in REITs or REIT ETFs, according to Nareit, the worldwide, representative voice for REITs.
If you want to invest in real estate, but you don’t have much capital, then investing in a REIT or a REIT ETF may be worth considering. Most REIT ETFs are passively managed, so they’re a good option if you want to “set and forget” your investment. Be sure to check in on its performance from time to time.
If you want to improve your knowledge of real estate investing, before taking the plunge and buying property, this may be another good reason to invest in REITs.
You can use REITs or REIT ETFs as a vehicle to grow your money while starting to learn about individual aspects of real estate investing. For example, if you know that in the future, you want to invest in apartment buildings, you could invest in a REIT that focuses on this area and see how the individual company handles themselves.
The advantages of investing in REITs and REIT ETFs
Anyone can get started investing in real estate through the vehicle of a REIT. Some REITs may offer shares for as little as $10 or $20 per share, which makes this method of investing appealing to newbie investors or those wanting to add real estate exposure to their portfolio without putting down a considerable amount of capital.
REIT ETFs that track indexes, often have low expense ratios, as should be the case because they’re passively managed. REIT ETFs can provide wider exposure to the real estate sector without having to risk capital on one individual company.
If you invest in real estate directly, you’ll have to pay for repairs and general upkeep at some point. Whenever a tenant has a problem with the property, you’ll have to get involved to source a local tradesperson to carry out the necessary work. If the tenant can’t afford to pay the required rent, you’ll have to get involved in the tedious process of rent recovery and possibly even eviction.
Even if you enlist a property management company to be that point of call and assist you with tenant/building management, you’ll still get phone calls from your property manager and have to fork out a percentage of your profits to cover their fees and any bills for maintenance.
REIT and REIT ETF investing offer a stress-free alternative way of investing in real estate, allowing you to dip your toe in the water without making a huge commitment, and without taking on much responsibility.
If your circumstances change and you need to convert your investment to cash, you can do so relatively quickly if your money is held in a REIT. You can sell shares from a REIT much like any other stock. Whereas if you needed to sell a physical property, this could take a significant amount of time and cost you more money in the process.
Imagine that you own a single apartment and that you don’t receive rent for a few months as you go through the process of attracting and vetting a new tenant. At this point, you may be likely to start losing money.
Many REITs control hundreds of different properties, which means you’re effectively spreading your investment risk broadly. If one property isn’t performing well, it probably won’t affect your bottom line.
Another point to note is that the real estate market doesn’t typically follow the same trends of the stock market. If the stock market is down, that doesn’t necessarily mean that the real estate market will be too. Of course, this can go both ways and serve as a negative also. However, investing in real estate in this way can help you diversify your overall portfolio and mitigate the level of risk you’re taking.
REITs aren’t subject to corporate income tax as long as 90% of any profits are paid to shareholders in dividends.
REITs are most certainly appealing to investors because of their income potential and the fact that it’s possible to see a return on investment reasonably quickly (dividends may be paid monthly or quarterly, for example).
Typically, REITs offer long-term total returns which are higher than corporate bonds and similar to those of value stocks.
Considerations for REIT and REIT ETF investing
Subject to taxation
When REIT dividends are paid out, you’ll need to pay regular income tax on the amount you receive, unless these payments are classed as qualified dividends, in which case capital gains tax applies. These taxes can, of course, eat into your profits.
With that said, REITs are generally exempt from taxation at the trust level, which means that real estate investors can avoid double taxation.
Less profitable than investing in real estate directly
Although REITs usually offer a high rate of return, investing in one is most likely to be less profitable than what you can potentially achieve from buying property directly and renting it out. With owned real estate, you can earn profits from rent and hopefully benefit from the property’s worth rising in value over time.
Very little control
As one of many investors in a REIT, you won’t have a say in what happens to the properties under its control. You’ll simply be putting your money into the REIT and trusting other people to make the right strategic decisions for the properties involved.
REITs carry risk
Like all investments, REITs and REIT ETFs carry risk. They are subject to the same economic factors that influence the real estate markets, for example, interest rates and employment rates. It’s crucial to understand the risks of your investment, the expected rate of return, the REIT’s historical performance, and how your money will be managed before you invest.
Investopedia advises staying away from non-traded REITs. If REITs aren’t traded publicly, you’ll be unable to research them. Non-traded REITS are classed as illiquid assets and often come with high upfront fees. Publicly-traded REITs are usually a safer bet.
How to Invest in REITs
For a comprehensive list of REITs, annual performance statistics and expense ratios, check out this data table from Nareit here.
There are a few ways you can get started investing in REITs. As an individual, you can buy shares in a REIT that is listed on a major stock exchange, just like you would any other public stocks. You can also invest in a REIT ETF (a basket of REIT securities), or purchase shares in a REIT mutual fund.
If you’re unsure what to invest in, it’s worth getting an investment advisor on board to help you analyze your financial objectives and make REIT investment recommendations. Alternatively, you might want to go through an investing platform such as DashVest, which offers access to real estate funds, including REITs and REIT ETFs.
DashVest is a relatively new platform that allows you to build a balanced real estate investment portfolio by giving you access to the types of deals traditionally only available to seasoned investing pros and banks. Learn more about DashVest and how to get early access to it.
Is REIT and REIT ETF investing right for you?
If you want to get into real estate investing, but don’t have the required capital, or simply don’t want to put all your money into a buying a property directly, than REIT investing might be for you.
By investing in a REIT ETF, you can gain diversified exposure to many different REITs within the broader real estate market in just one single investment. You won’t have to risk your money on one individual REIT, and you’ll also benefit from low-cost expense ratios in the process.
Choosing to invest in a REIT which focuses on a specific aspect of the real estate sector will require a bit more legwork on your part, but may offer better returns than an ETF. Although a REIT will have its own managers, you’ll still have to do due diligence and make sure the REIT in question has good management in place and a robust business plan.
For more extensive information about REITs, please check out the Nareit website, where you can analyze REIT data and read industry news.