Are you looking for a way to invest in real estate, but you don’t have time to deal with tenants or maintain properties? Have you heard of real estate investment trusts, but you’re not sure if they are a suitable investment for your portfolio?
There are more than 225 REITs registered in the US that trade on a national stock exchange. If you are considering an investment in a REIT, there are a lot of companies to choose from.
Buying shares in a real estate investment trust can be a great strategy when it comes to your wealth management choices. Here’s a guide to help you learn more about REIT investing.
What Is a REIT?
A REIT is a real estate investment trust. That’s a company that invests mainly in real estate assets. Individual investors can buy shares in the company. This allows them easy access to the real estate market.
Most REITs trade on public stock exchanges, but some REITs trade privately. Publicly traded REITs have the advantage of being very liquid assets.
The primary purpose of a REIT is to generate income from real estate assets. This income comes from several different streams.
How to Invest in REITs?
Three different types of REITs trade on the public stock market and it’s easy to buy shares. Each type of REIT tends to focus on a different sector in the industry.
Equity REITs are the most common type. These companies buy and manage rental properties. They also earn income from rents and management fees.
Mortgage REITs (mREITs) invest in real estate mortgages, providing a source of financing for real estate investors. These companies earn income from mortgage interest.
Hybrid REITs are a combination of the two types. They hold rental properties and also invest in mortgages. This REIT blends the strategies of both types, making them a powerful investment holding.
There are two types of REITs that don’t trade on the stock exchange. They are public REITs registered with the SEC, and private REITs, which are not.
You can purchase shares in a REIT mutual fund, which is a professionally managed portfolio holding shares in different real estate investment companies. They aren’t traded on the stock market but can be purchased privately.
Another option is to hold shares in a REIT exchange-traded fund (ETF). These funds are like mutual funds but are traded on the stock exchange, so they’re a bit more liquid than mutual funds.
A wealth management company can provide you with more information on REIT investing. They will help you make an informed choice.
What Sectors Do REITs Include?
There are many types of REITs, and most of them specialize in one part of the industry. Different sectors can be more traditional, such as offices, residential apartments, and commercial or retail malls.
Commercial REITs usually have net lease arrangements where the tenant is responsible for rent and other operating costs, including taxes and maintenance.
REITs also specialize in cell towers, warehouses, or data centers. Some companies hold assets in several different sectors, offering additional diversification within the REIT itself.
REIT Investing Provides Diversification
Diversification is the practice of spreading your investments over a wide range of sectors and industries to reduce your portfolio risk.
Investing in highly correlated assets can increase your risk. Highly correlated assets are closely related, and they tend to perform the same way during market events.
When you invest in a single sector, banking, for example, you are subject to a higher level of risk when the market responds to world events that have a negative effect on that sector.
Owning shares in a REIT improves diversification in your portfolio in several ways.
- The company holds a variety of different assets within the REIT itself.
- Real estate investments have a low correlation to most other asset classes held in an investors’ portfolio.
Diversification reduces overall investment risk and smooths out the returns from your portfolio.
Rules For REITs
Real estate investment trusts were created in the US in 1960 to allow individuals to profit from commercial real estate without going out and buying the assets on their own.
In the US, provisions in the Internal Revenue Code established the rules. To qualify as a REIT, the company must hold 75 percent or more of its assets in real estate. Also, at least 75 percent of its gross income must come from real estate income such as rents or interest on mortgages.
The company must also payout at least 90 percent of its taxable income to investors as dividends each year.
These requirements make real estate investment trusts a reliable way to receive a steady flow of income. They also have the potential of long-term capital appreciation as the assets grow in value.
Investors are responsible for paying income tax on the amounts they receive from the REIT. The IRS considers these payouts to be regular income, so they can’t be treated as dividend income.
How to Compare Different REITs?
When comparing different REITs, investors use funds from operations or FFO to evaluate the company’s operational performance.
FFO is important because it removes one-time transactions that inflate or reduce a company’s cash flows. One example is cash received from the sale of a property held within the REIT.
Investors use the following steps to calculate funds from operations:
- Calculate earnings for the period.
- Subtract depreciation and amortization.
- Add back losses on sales of assets.
- Subtract gains on sales of assets and interest income.
Most REITs will report funds from operations on a per-share basis. FFO per share is like EPS or earnings per share, which is an indicator used to evaluate other companies.
Get Wealth Management Assistance Today
Now that you have more information about real estate investment trusts, you can understand why REIT investing is an affordable way to get into the real estate market.
There are many factors to consider when you make investment decisions, and it’s always helpful to have a professional to assist you.
Contact Bogart Wealth today if you’re looking for wealth management services in McClean, VA, or Greater Houston, TX.