REITs: Are they the right Investment Strategy for you?
How Real Estate Investment Trusts Emerged
In 1960, Congress created Real Estate Investment Trusts — or REITs (pronounced REET) — to give all citizens the opportunity to invest in and benefit from income-producing real estate. Similar to how shareholders benefit from owning stocks in other corporations, a stockholder of a REIT earns money from the income produced by the investment — meaning they do not have to personally buy or finance a property on their own. The creation of REITs continues to allow investors to diversify their portfolios while remaining completely passive — all sales, maintenance, management, and rent collection will be handled by the company operating the REIT. These “companies” are treated by the Internal Revenue Code as a corporation.
Today, a REIT can be defined as a group categorized as a company that operates, owns, or finances income-producing real estate. Many REITs will focus their energy on buying primarily in one type of real estate investment, but others have a variety of different property types.
In order to be recognized as a REIT, Congress implemented rules that these investment strategies must follow, and today, the IRS enforces these rules.
REITs are modeled after mutual funds
They are required to distribute 90% of taxable income annually to shareholders as taxable dividends, meaning a REIT cannot keep the money it’s acquired
They receive dividends paid deduction, meaning no taxes are paid if it is 100% distributed
REITs must be widely held by shareholders
REITs have to primarily invest in real estate
75% of the sales must come from real estate interests, rent, or the sales conducted in real estate
75% of the assets must be real estate assets
95% of the income must be passive, with a long-term investment outlook
Types of REITs
Depending on the type of real estate property the company is investing in, REITs will be categorized in one of two ways:
Mortgage REITs — Income from Mortgage REITs can finance both residential and commercial properties. Most of their revenue comes from interest earned on their investments in mortgages and mortgage-backed securities.
Equity REITs — This type of REIT typically invests in offices, shopping centers, hotels, and apartment complexes. The revenue collected from rent is what drives Equity REITs.
You can invest in either type of REIT and still maintain your passive status as an investor. If you are not looking to put cash up front to finance a property, opting into a REIT is a great way to collect passive income, diversify your portfolio, and grow your wealth. REITs can provide promising returns through long-term capital improvements and have a seemingly low-risk factor when it comes to your portfolio.
How to Invest in REITs
REITs can be advertised to investors in a number of ways. Publicly Traded REITs are regulated by the SEC and are listed and traded on major stock exchanges. Public Non-Listed REITs are also regulated by the SEC but are not listed. Private REITs are not regulated by the SEC or listed on major stock exchanges, which makes these illiquid investments since investors are unable to easily flow in and out of investment transactions like publicly-traded REITs. Private REITs require institutional or accredited investors to have a certain net worth to qualify for the investment opportunity. Public non-listed REITs, however, are open to non-accredited investors. Both REIT options have minimums investment requirements which differ based on the type and size of the REIT. So, how do you go about finding the right REIT to put your money into?
If the share is public, you will have access to it through the stock exchange and can purchase shares publicly, similar to a regular stock. You can also purchase your shares in a REIT mutual fund or exchange-traded fund (ETF). In fact, this is how many Americans access REITs — through mutual funds and ETFs in their pensions, 401(k)s, and IRAs. Almost all 401(k) and pension plans have some form of REIT allocations.
To invest in non-traded REITs, investors often work with an individual broker or financial advisor. Non-traded REITs are high-commission investment products, in which sales representatives, who receive a commission, present different deals.
As always, reach out to an experienced agent/broker or financial advisor you trust to help guide you through this process. A little work in the planning stages can lead to a very passive approach to making money, so do not hesitate to sit down and discuss your financial goals with them. They can advise you on the best REIT for your future planning.
This information may not be used as a substitute for legal and/or financial advice and you should consult your attorney and or financial advisor for professional advice if you have any questions relating to this advisor guide.