A Guide to Investing in REITs

Source: Thinkstock

Source: Thinkstock

You’re looking for a way to increase your investments and portfolio. If you haven’t already looked at investing in the real estate world, it’s worth taking into consideration. Real estate investment trusts are a simple way to invest in real estate. Recently out of favor with the real estate market crash, REITs are making a comeback as the market stabilizes. All REITs require is that you buy shares in the trust, rather than deal with the many, complicated steps that go along with purchasing physical property. Interested in learning more? Here’s what you should know before investing in REITs.

What To Expect:

“When you buy a share of a REIT, you are essentially buying a physical asset with a long expected life span and potential for income through rent and property appreciation. This contrasts with common stocks where investors are buying the right to participate in the profitability of the company through ownership,” Investopedia writes. According to Brass, REITs are required to pay out 90 percent of taxable profits in dividends, meaning that as long as the investments are making money, you’ll see a nice, steady return. The share prices can also gain value, similar to regular stocks. REITs also offer a bit of a safety net for investors, because they’ll always have rights to the property underlying the trust. Many REITS are also accompanied by dividend reinvestment plans.

Different Types:

  • Equity REITs: These REITs buy and invest in properties. Their primary source of revenue is rent, Brass writes.
  • Mortgage REITs: Money is loaned to buyers to purchase mortgages and mortgage-backed securities. Revenue is generated from the interest earned on the loans.
  • Hybrid REITS: This is a combination of equity and mortgage REITS, meaning revenue is generated by both rent and earned interest.
  • Residential REITs: This type of REIT specializes in apartment buildings and/or other residential properties leased to individuals, according to About.
  • Retail REITs: Malls and shopping centers are included in this sector.
  • Office and Industrial REITs: The office sector of REITs is typically the largest. The office sector typically has longer lease terms, which means that when rent is declining and there is lower occupancy, tenants will have less-profitable rates. However, if a property is filled and there is high demand, REITs increase. Industrial REITs typically generate steady, predictable cash flow, writes About.
  • Health Care REITs: This sector builds, acquires and leases specialty buildings, such as hospitals, nursing homes, medical buildings and assisted-living facilities.
  • Self-Storage REITs: Corporate customers make up a significant portion of storage rentals, and this sector is fairly resistant to recessions.
  • Hotel and Resort REITs: This one is closely linked to how the economy is doing. If the economy is bad, people travel less. Investors in hotel REITs have to be careful they don’t overbuild and know what the economic outlook is supposed to be.

Requirements for REIT Status:

In order to retain its special tax status, every REIT must pass these four tests annually, writes About.

  • The REIT must distribute at least 90 percent of its annual taxable income, excluding capital gains, as dividends to its shareholders.
  • The REIT must have at least 75 percent of its assets invested in real estate, mortgage loans, shares in other REITs, cash or government securities.
  • The REIT must derive at least 75 percent of its gross income from rents, mortgage interest, or gains from the sale of real property.
  • The REIT must have at least 100 shareholders and must have less than 50 percent of the outstanding shares concentrated in the hands of five or fewer shareholders.

How to Invest:

You can invest in REITs by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate, Investopedia writes.

Keep in Mind:

“Though REITs offer easy access to the real estate market, REIT performance depends on which sector of real estate the REIT is invested in (residential, commercial or both) and on macroeconomic forces (think the housing crash and ensuing financial crisis),” says Brass. Make sure before investing you know exactly how the economy is doing, how it’s expected to do in the future, and how that will impact the specific type of REIT you’re investing in.