A REIT is a real estate investment trust that owns and operates real estate and real-estate-related assets such as mortgages, land, property, and more. Investors who want to invest in real estate may wish to purchase shares of a REIT to diversify their portfolio.
Before you invest in REITs, be sure you understand what they are, how they work, and whether they are a good fit for your portfolio. Here’s everything you need to know about investing in REITs.
How To Invest in REITs in 5 Steps
- Understand what an REIT is and how it works.
- Be aware of the risks associated with REIT investments.
- Review the pros and cons of REITs to confirm they meet your investment objectives.
- Open an account at a reputable brokerage if you don’t already have one.
- Research which REIT to buy, then regularly monitor your investment.
What You Need To Know Before You Invest in REITs
As it is with any investment, always do your due diligence before investing in a new fund or stock. Be sure you understand what a REIT is, how it works, and the type of investors who buy REITs.
A real estate investment trust (REIT) is a company that focuses on owning and operating income-producing real estate assets. Examples of real estate assets a REIT may hold can be commercial buildings, hotels, apartment complexes, warehouses, and even real-estate-related assets such as mortgages or loans.
Congress created REITs in 1960 so that individual investors with smaller amounts of money could still invest in and benefit from income-producing real estate. In other words, a REIT will allow anyone to own and finance real estate just like they would invest in a publicly-traded stock.
REITs are meant for investors at all levels of wealth. Those with large and small amounts of money can add REITs to their investment portfolios.
Understand the Risks of Investing in REITs
Like investing in stocks, REITs also have risks. Some risks of investing in REITs may include:
- Market risk: REITs are correlated with the real estate market. Should the real estate market lose value, REITs are likely to follow suit.
- Interest-rate risk: The real estate market is often affected by current interest rates. Should interest rates change up or down, it may affect the real estate market as a whole and thus an REIT.
- Occupancy-rate risk: REITs have payouts that are expected to be maintained. To maintain these, the occupancy or usage of the properties need to maintain certain levels. Should the use of the properties be vacant, then the payouts may not meet expectations.
- Property-specific risks: Some REITs may be more invested in mortgage notes. Others may be focused on storage units. Some could focus on apartments. Depending on the REIT you invest in, there may be property-specific risks based on what type of real estate the respective REIT invests in.
Pros and Cons of Investing in REITs
REITs can be a good hedge against inflation
Potential for high leverage
Rising interest rates could decrease value
- Higher dividends: REITs typically have higher dividends than the general equity investment. This is because REITs are required to payout at least 90% of their taxable income to their shareholders annually. Most REITs will even pay 100% of their taxable income to shareholders.
- REITs can be a good hedge against inflation: Between 2000 and 2020, REIT dividends outpaced inflation in all but three years—2002, 2009, and 2020, according to an analysis of data from the National Association of Real Estate Investment Trusts (NAREIT). Furthermore, when the cost of housing increases due to inflation, real estate can be an excellent place for an investor to profit accordingly.
- Diversification: REITs provide an excellent option for diversification—both for diversifying real estate investments and diversifying the assets you have in your overall investment portfolio. REITs typically follow the real estate cycle, which typically lasts at least 10 years; equity cycles last closer to 5.75 years.
- Dividend taxes: Although REITs don’t pay corporate taxes, they are taxed higher on the dividends they payout. That means you as the investor are in charge of paying taxes on the dividends you receive from a REIT. Dividends from REITs are generally treated as ordinary income and are taxed at your normal income tax rate.
- Potential for high leverage: Real estate often has mortgage debt tied to the investment. Some REITs may acquire new properties that come with more debt, which means they have the potential to be improperly managed and incur high levels of debt. A REIT may have a high debt-to-total assets ratio, which means it has a high leverage ratio, and that may not sit well with investors.
- Rising interest rates could decrease value: REITs may lose value when interest rates increase because higher interest rates tend to decrease the value of the real estate owned in a REIT. Higher interest rates may also make the dividends from a REIT less attractive to investors who could benefit from other high-interest, fixed-income products or accounts.
How To Start Investing in REITs
How does one physically invest in REITs? The process is quite simple. First, open a brokerage or investment account, decide which REIT to buy, and make your first transaction. Here’s how to do that.
Open an Account
If you haven’t already, you need to open an investment account with a reputable brokerage. Companies you may want to consider include Fidelity, Vanguard, or Charles Schwab.
The process is pretty similar in most cases, regardless of where you open it. The firm will need your basic contact info, your Social Security number, a valid ID, and will likely ask you about your income and occupation. Lastly, you will be asked a few questions about your experience investing and whether you have any direct family members who are investment licensed or major shareholders in a public company. You can sign up online via the brokers app, or in person if the firm has a branch location.
Your retirement account may also be a place where you can invest in REITs. For example, in 2015, the NAREIT estimated there were approximately 70 million people in the U.S. who owned REITs through their pension funds or retirement savings accounts such as a 401(k) plan.
Decide Which REIT To Buy
Once you’ve opened an investment account, you need to decide which REIT you’d like to invest in. This could be anything from a fund that invests in hundreds of real estate properties, such as the Vanguard Real Estate Index Fund (VGSLX), or a REIT that owns and operates cellphone towers worldwide, such as American Tower Corporation (AMT). Prologis (PLD) is another REIT that owns properties in more than 19 countries, many of which are warehouses rented to major companies such as Amazon and The Home Depot. The iShares Residential and Multisector Real Estate ETF (REZ) is a REIT exchange-traded fund (ETF) that includes companies that own and operate residential and multisector real estate properties.
After deciding which REIT you want to add to your portfolio, make your first transaction. Consider any investing fees with your brokerage and any potential expense ratios a fund may charge (depending on the REIT you invest in).
What To Watch Out for After You Invest in REITs
Investing often requires investors to be patient to see some growth, but that doesn’t necessarily mean you can “set it and forget it.” Be sure to monitor your investments regularly and seek the advice of a licensed investing professional.
There are three types of dividends with REITs, and each may be taxed differently. Ordinary income, capital gains, and return of capital are all treated differently, so it’s important to understand how REIT dividends are taxed before you invest.
Should You Invest in REITs?
REITs are typically riskier investments for short-term investors due to their sensitivity to interest rates and ever-changing market trends. However, in most cases, people looking to invest in REITs should have a long-term time horizon in mind. If you're interested in investing in real estate and find a REIT you want to invest in, do your research, understand any fees or taxes you’ll pay, then make the decision that is best for you and your financial future.
Frequently Asked Questions (FAQs)
How can beginners invest in REITs?
Beginners can invest in REITs by opening an investment account, researching a reputable REIT to invest in, and making their first transaction. Seek advice from a professional if needed.
Do you need a lot of money to invest in REITs?
Some ETF or mutual-fund REITs require a minimum investment amount. However, if you invest in REITs with a firm that allows fractional shares investing, or if you buy just one share through an investing app, you may be able to start with a much-smaller dollar amount. Some REITs may cost less than $50 per share; others may cost more than $100.
What is the best way to invest in REITs?
For most, the best way to invest in REITs is to invest in a publicly-traded REIT or REIT fund after doing research on the fund and confirming it meets your investment objectives. Non-traded REITs come with more risks, such as a lack of liquidity, so be sure you understand what type of REIT you’re investing in.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.