What are REITs? How to invest in a real estate investment trust this year

0



From afar, owning real estate as an investment looks like a goose that lays the golden eggs: Play your cards right and you could earn passive income for years. But few people have the money or the time to buy and manage properties on their own. That’s where real estate investment trusts (REITs) come in.

So-called REITs allow everyday investors to own and profit from real estate, an asset that experts say rounds out a portfolio of stocks, bonds and cash.

“REITs represent a very low-cost, effective and liquid means of investing in commercial real estate that is truly available to the general public,” says Abby McCarthy, senior vice president of investment affairs for the National Association of Investment Trusts in Real Estate (Nareit), an advocacy group.

What is a REIT?

A REIT is a company that owns, operates, or finances income-producing real estate, such as shopping centers, malls, hotels, medical facilities, apartment buildings, and office complexes. More than half a million properties in the US they are owned by REITs, according to Nareit.

Buying shares in a REIT is like buying shares in any other company, except that a REIT generates income exclusively from real estate.

McCarthy says commercial real estate has historically been in the hands of wealthy, institutional investors, but REITs give ordinary investors a slice of the pie. “REITs are total return investments, so they typically provide high dividends plus the potential for modest long-term capital appreciation,” she says.

How REITs work

A REIT collects rent, operating expenses, or interest payments on the properties in its portfolio. It then turns around and gives the majority of that income to its shareholders in the form of dividends. According to nareit dataREITs listed on major stock exchanges paid more than $51 billion in dividends to investors in 2020.

The properties in a REIT often share a general theme. A health REIT, for example, might own or finance hospitals, senior living facilities, and medical office buildings; a residential REIT would have apartment buildings and student housing; and a self-storage REIT would own and manage the storage facilities. Diversified REITs include a mix of property types.

The IRS requires that a company meet these requirements to qualify as a REIT:

  • You must distribute at least 90% of your annual taxable income to your shareholders
  • Must be managed by a board of directors or trustee
  • Must be registered as a corporation
  • You must have at least 100 shareholders.
  • You must derive at least 95% of your gross income from real estate, and at least 75% must come from specified sources.
  • You must invest at least 75% of the value of your total assets in real estate, cash or cash-like vehicles, and Treasury bills.

The 3 types of REITs

REITs can be separated into three broad categories, the main difference between them being whether they own/manage or finance real estate. Some do both.

  • Equity REITs: This type of REIT owns multiple properties that are typically concentrated in one industry, says McCarthy. The tenants pay the rent to the REIT, which turns around and pays dividends to its shareholders.
  • Mortgage REITs: REITs that finance, rather than own, property are called mortgage REITs or mREITs. Income is earned from interest on primary mortgages or mortgage-backed securities and is paid to investors as dividends.
  • Hybrid REITs: These REITs own and finance properties, using both strategies to generate income.

REITs are also classified by how they are available to investors: on or off major stock exchanges. Here is more information on the three types of business status:

  • Publicly traded REITs: Equity REITs are publicly traded, meaning they are listed on major stock exchanges, such as the New York Stock Exchange (NYSE). Because they are regulated by the Securities and Exchange Commission (SEC), they tend to be more transparent than REITs that are not publicly traded. REITs can be listed directly on an exchange (there are 209 publicly traded REITs as of October 2022, according to Nareit) or they can be part of a mutual fund or exchange-traded fund (ETF) made up of multiple REITs. Like any publicly traded security, REITs carry risk, says McCarthy. Factors as varied as the current political climate, interest rate environment, geography and tax laws can affect the performance of an equity REIT.
  • Unlisted public REITs: Unlisted REITs are not listed on national stock exchanges, but are still regulated by the SEC. They tend to have higher minimum investment requirements and longer holding periods, making them more difficult to sell (ie less liquid) than publicly traded REITs and therefore riskier.
  • Private REITs: This unregulated class of REITs is reserved for high net worth investors and financial companies that manage pension plans. Yields can be higher, but the yield is often more difficult to track.

High-dividend REITs are particularly attractive to investors when the prices of everyday goods and services, such as rent, are rising. “It has inflation protection that some assets don’t,” says Michael Becker, associate wealth advisor and investment analyst at Hightower Wealth Advisors in Saint Louis. However, he adds, the impacts of COVID-19 have shaken commercial real estate. Buyers are turning more to e-commerce and many businesses have not returned to offices.

“You can’t count on every real estate trend from the last 10 years for the next 10 years,” he says, a reminder for investors to be judicious when choosing REITs to invest in.

How to invest in REITs

by Nareit online database displays the current stock price, annual returns, and dividend yields for more than 180 publicly traded REITs. You can buy stock using a tax-advantaged brokerage account or a tax-advantaged retirement account, such as your workplace 401(k) or an IRA.

“REITs are publicly traded securities, so investors can access them by choosing direct shares,” says McCarthy. “But in reality, most investors invest in REITs through actively managed mutual funds, index funds, or ETF products.”

A fund is a basket of several companies. It does the work of researching, vetting, and selecting REITs that align with a certain goal or value. By owning stock in multiple companies, McCarthy says investors can increase their returns without taking on more risk.

Keep in mind that index funds and ETFs may be subject to investment minimums, though they’re typically less than $1,000, and you’ll have to pay a fee, known as an expense ratio, to cover administration costs.

If you are interested in non-tradable REITs, check out platforms like Fundrise or DiversyFund. If you qualify as a accredited investorconsider a platform like Yieldstreet or speak directly with a financial advisor.

But remember: Any investment you buy and sell through a retirement account generally cannot be accessed without penalty until retirement age. If you’re looking for a current stream of dividend income, a brokerage account may be a better option, although there are tax rules to consider.

How REITs are Taxed

A REIT has to be registered as a corporation, but generally does not pay corporate taxes. Instead, company income flows as dividends to shareholders, who are responsible for paying income taxes.

In general, dividends paid through REITs are considered “non-qualified” for tax purposes. That means an investor’s ordinary income tax rate applies, not the lower capital gains tax rate that applies to long-term stock gains.

“For people with high incomes, that [rate] it can be close to 40% depending on what state you’re in,” says Becker. “For people with lower incomes, it can be in the middle or upper teens.”

Some dividends are a mix of ordinary income and capital gains. This happens, for example, when a REIT sells a property it has owned for more than a year and gives part of the profits to shareholders.

Ultimately, though, the account you use to invest in REITs determines the tax treatment of your dividends. In a tax-deferred account like an IRA, you avoid paying taxes on dividends each year, in part because you’re not pocketing the money yet. Dividends are reinvested and pooled with your other investment principal and earnings, and are taxed as ordinary income when you make withdrawals in retirement. In a brokerage account, REIT dividends are taxed annually.

Food to go

The performance of real estate investments tends not to track that of stocks or bonds, making them a great diversification tool. For investors with liquidity needs, a REIT can be a smart alternative to owning physical real estate.

REITs offer investors a way to benefit from some of the more stable aspects of the real estate market, even when its path is largely unpredictable. Whenever people need a place to conduct business, be it a retail store, an office, or a health care facility, they will pay rent. And as long as a REIT collects rental payments, it must share at least 90% of that income with investors.



Source link