Investing in Real Estate Investment Trusts (REITs): 101

Investing in real estate is a great way to build wealth over time and even make a very handsome income as a career. Whether you buy a property to rent out, fix and flip a fixer-upper, or just buy in hopes of a property appreciating in value, making a lot of money in real estate is possible.

But there’s another way to make money in real estate without actually having to deal with physical properties: with REITs.

What Are REITs?

Real Estate Investment Trusts (REITs) are companies of shareholders that own and operate different types of properties that generate income. The properties are typically large scale and include office buildings, industrial warehouses, commercial units, shopping malls, apartments, hotels, and storage facilities.

Instead of developing properties in an effort to resell them for a profit, REITs buy and develop properties mainly to operate them to generate an income over the long haul.

Many REITs are publicly traded on the stock exchange, while others are private. It’s important for investors to distinguish between the two before deciding which type to invest in. You can buy REITs through a broker, or purchase shares in a REIT mutual fund or exchange-traded fund (ETF).

When you purchase shares of a REIT, the REIT pools that money with other investors’ capital to make investments. REITs do their due diligence when scoping out properties to buy and make informed purchasing decisions in order to ensure the properties that are being added to the investment portfolio will be big income drivers.

The REIT earns income from rent payments or from interest on real estate debt. The dividends are then distributed among the investors according to how many shares they’ve got invested.

What Types of REITs Are There?

Equity REIT – These are the more common types of REITs that invest in real estate to generate income from rent. Mainly, rent is collected from leases. The money collected is then distributed as dividends to shareholders who have a stake in these properties.

Mortgage REIT – These types of REITs either lend money to real estate owners or purchase existing mortgage-backed securities. Income is generated as a result of the interest earned on the loans, minus the cost of funding such loans.

Hybrid REIT – These combine investments in properties and mortgages. In this case, REITs own properties while providing mortgages to real estate investors. Income with these types of REITs is generated from both rent and interest earned.

Why Invest in REITs?

There are plenty of reasons why you might choose REITs, including the following:

Easy to liquidate – With publicly-traded REITs, you can enjoy liquidity by easily selling your shares.

Provides a steady source of income – The dividends that are earned from a REIT can provide you with a steady stream of income at each pay period.

Diversified investment portfolio – It’s suggested that investors have a diversified investment portfolio that’s made up of different investment products in order to protect them in case one particular investment vehicle does poorly. Throwing REITs into the mix can be a great way to diversify your portfolio.

Relatively safe investment – Generally speaking, real estate tends to do well in terms of appreciation, and REITs are directly impacted by the level of appreciation of the properties invested in.

Hands-off investment – REITs don’t usually require much involvement on your part, so there’s little for you to do.

Are There Any Drawbacks to REITs?

While there are plenty of reasons why you might want to consider looking down some capital in REITs, there are some risks that you should know about first.

Fees – Many REITs charge high fees in exchange for all the services provided to find and buy income-generating properties, as well as for property management and administrative costs. These fees can be rather high and can eat into your profits.

Little control – Since you don’t actually own the property on your own, you don’t have the same level of control over your investment as you would if you owned a physical property yourself.

Slow growth – About 90% of profits made are distributed among investors. That only leaves 10% to be reinvested back into the company, which means growth can be rather slow.

Vulnerability to market volatility – REITs that are publicly traded on the stock market are subject to the same risks as other stocks. And fluctuation in share prices will directly affect investors’ bottom line.

The Bottom Line

REITs present a unique investment opportunity for investors who are interested in investing in the real estate market in addition to owning physical property. If you’re thinking about adding this type of investment vehicle to your portfolio, make sure you weigh the pros and cons. Consult with a real estate agent and investment advisor to help you decipher which avenue is best for you.