Have you ever been curious about investing in real estate? Or maybe you’re interested in diversifying your portfolio?
This is a common curiosity amongst investors. However, traditional real estate is difficult to invest in – and difficult to cash out of once you’re invested.
But you don’t have to put up colossal amounts of cash to get into the real estate game. You don’t have to worry about buying, managing, or financing a house or office space.
You can invest in real estate just as easily as you can in any other company or asset class. How is this possible? Through REITs!
What is a REIT?
Real Estate Investment Trusts, or REITs, are companies that own, invest in, or finance properties, including residential, office, and commercial real estate. REITs were established by Congress in the 1960s to enable the general public to invest in real estate – without the usual barriers that prevent you from doing so.
For a company to qualify as a REIT, it must meet several qualifications. For example, at least 75% of a REIT’s total assets must be real estate. Further, at least 75% of a REIT’s revenue must be derived from rent, interest on financing, or property sales.
There are four categories of REITs:
- Equity REITs
- Mortgage REITs
- Public Non-Listed REITs
- Private REITs
For the purposes of this post, we’re going to focus on Equity REITs.
REITs may build a diversified portfolio of several types of property or a concentrated portfolio of a single type of property. Here are a few examples of property that a REIT may invest in:
- Shopping centers
- Data centers
- Corporate offices
- Parking garages
- Storage facilities
How do REITs Make You Money?
As we’ve established, a REIT’s primary investment is property. How do REITs make money so that, in turn, they make YOU money? Equity REITs derive most of their revenue from rent on their properties. Here’s an example using simple, round numbers.
Let’s say a REIT owns 15 apartment complexes. Each complex has 100 tenants who each pay $1,000 a month in rent to live there. That equates to $1,500,000 a month in gross revenue, or $18,000,000 a year!
In reality, these apartment buildings would have monthly expenses for upkeep and property management. So after deducting these costs and other corporate expenses, the remainder would be distributed to the REIT’s shareholders – which would be you!
In sum, REITs make money through rent collection, interest on their investments in real estate, or sales of properties. After factoring in expenses, this money then flows to its investors (you) via annual, quarterly, or even monthly dividends.
You can also profit off of REITs by selling your shares. Like any other stock, a REIT’s price will fluctuate over time. If you’re reached your investment goals and are ready to cash out, you can sell your shares and recognize returns.
What are the Benefits of Investing in REITs?
Every REIT is required to distribute at least 90% of its taxable income to shareholders – and most REITs dividend out 100%. In other words, a REIT is not allowed to retain its earnings.
Why would a REIT pay out 100% of income? Because then it doesn’t pay taxes!
As an investor, this is the most important quality of a REIT that sets it apart from other asset classes. So long as a REIT is making money, you’re getting a dividend.
Traditional real estate investments are illiquid. It could take months or even years to get your money out. This is the biggest risk of investing in traditional real estate.
However, REITs trade on stock exchanges – which are liquid by nature. You could buy shares of a REIT on Wednesday and sell on Friday.
3. Transparency and Diversification
Since REITs are traded on a public exchange, they’re required to abide by the rules and regulations of the Securities Exchange Commission, or the SEC. This provides a great deal of transparency into a company’s operations. In turn, this is comforting to investors, as public companies are highly-scrutinized with a ton of oversight.
If you’re looking to spread out your portfolio risk, REITs are also an effective vehicle for diversification.
4. Low capital requirement
Traditional real estate, such as buying houses or office spaces, requires a high amount of capital to invest. Not everyone has pallets of cash lying around to drop on townhomes in a budding community.
REITs allow you to indirectly own properties and capitalize on the revenue they generate. Buying shares of REITs is a cost effective method for entering this market space.
How do You Invest in REITs?
Investing in REITs is simple. You can buy REITs directly or buy portfolios of REITs via Exchange Traded Funds, or ETFs. There are over 180 REITs available to trade on the New York Stock Exchange. Collectively, the market capitalization for REITs on the NYSE is over $1 trillion.
Through their concentrated or diversified portfolios of properties, REITs earn money by collecting rent, which is then ultimately distributed to shareholders in the form of dividends. Since REITs are required to distribute at least 90% of taxable income, REITs provide investors with a healthy, recurring cash flow.
REITs allow you to invest in property without the usual risks associated with buying and managing real estate – such as illiquidity and high upfront costs. In terms of annual return, they’ve also been the highest performing asset class since 2004.
If you’re looking to enter the real estate market or want to diversify your portfolio, consider investing in REITs.
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