Did you know that Congress established REITs in 1960?
When building equity or fixed-income portfolios, real estate investment trusts (REITs) should be taken into account.
Diversification, better returns, and/or reduced risk may all be gained by investing in a REIT. With their capacity to yield dividends and capital appreciation, they form a perfect counterpoint to stocks, bonds, and cash investments.
But, if you’re new to this form of an investment opportunity, no worries. Read on for our full breakdown of REITs, and how they work.
What Is a REIT?
A REIT (pronounced “reet”) is a real estate investment trust that maintains a portfolio of commercial real estate or loans secured by commercial real estate.
To ensure that all investors, particularly small investors, had access to income-producing commercial real estate, Real estate investment trusts (REITs) bring together the greatest aspects of both real estate and equity investing.
Understanding How Real Estate Investment Trusts (REITs) Work
Mutual fund-like REITs give investors more diversity than they can achieve on their own. It is common for REIT firms to invest in a portfolio of investment assets such as office buildings and apartments.
Tenants pay rent to the company, which owns the properties and reaps the financial benefits of doing so. As a result, they may subsequently pay out dividends to their stockholders. Even though REITs must disperse at least 90% of their profits in dividends, many give out 100%.
Short-term dangers may affect certain property kinds as well. For instance, REITs took a hit in 2020 due to the COVID-19 pandemic. However, in 2021, the industry rebounded with a 22% year-over-year gain.
Types of Reits: Starting With Retail
Shopping malls and freestanding retail make up around 24% of REIT assets.
It is the single largest investment of this kind in the United States. If you shop at a mall often, chances are it is owned by a real estate investment trust (REIT).
The retail business itself should be examined before making an investment in retail real estate. Is the company’s current financial situation sound, and what is the company’s long-term outlook?
Retail REITs create money by charging tenants rent. A retailer’s monthly payments might be delayed or even missed if they’re having cash flow issues as a result of low sales. This could lead to bankruptcy.
A new renter must be located at this time, which is seldom simple. This means that REITs with the strongest anchor tenants are essential to invest in. Among them are supermarkets and hardware businesses.
You can also explore other avenues for commercial real estate investing.
Residential REITs
Rental apartment complexes and mobile homes are included in the portfolios of REITs.
Investing in this sort of REIT requires careful consideration of a number of issues. There are several factors that contribute to an apartment market’s success. These include the cheap cost of living and proximity to public transportation.
Because of the high cost of single-family houses in cities like New York and Los Angeles, more individuals are opting to rent, which pushes up the rent that landlords may demand.
Large metropolitan areas are thus of particular interest to the largest residential REITs.
Investors should keep an eye out for population and employment growth within a certain market. When a community has a net influx of new residents, it’s usually a sign that employment opportunities are plentiful and the local economy is expanding. Vacancy rates are decreasing and rents are rising as an indication that demand is increasing.
Residential REITs should perform well as long as the supply of apartments in a specific market stays limited and demand rises. As with any company, those with the strongest balance sheets and the most readily accessible money tend to do better than their competitors.
REITs in the Healthcare Sector
As the population of the United States ages and healthcare prices rise, healthcare REITs will be an intriguing area to keep an eye on.
Hospitals, medical centers, nursing homes, and retirement homes are all properties of healthcare REITs. The health care system is strongly linked to the profitability of this real estate.
These institutions’ managers depend heavily on occupancy fees, payments from Medicare and Medicaid, as well as private donations to keep their doors open. Until the financing of healthcare becomes more secure, healthcare REITs will continue to exist.
You should seek a healthcare REIT with a diverse client base and assets in a variety of property types to find a good fit. Spreading your risk is just as important as concentrating your efforts. Hospitals and other healthcare facilities benefit from an older population’s increased need for medical services.
Office Real Estate Investment Trusts (REITs)
Office REITs invest in office properties. Tenants who sign long-term leases are the primary source of revenue for landlords. Anyone considering investing in an office REIT has four main concerns:
- Do you know how much unemployment there is in your area?
- What are the vacancy rates?
- What is the state of the economy in the region where the REIT has invested?
- Exactly how much cash does the company have on hand to make purchases?
Try to discover REITs that invest in areas with high economic growth. In Washington, D.C., owning a few middling buildings is preferable to owning great office property in Detroit, for example.
Mortgage-Based REITs
Mortgages account for around 10% of REIT assets, which are not in real estate at all.
Fannie Mae and Freddie Mac, government-sponsored firms that purchase mortgages on the secondary market, are the most well-known but not always the best investments.
But the fact that this REIT invests in mortgages rather than stock does not imply it is free of danger. Mortgage REIT book values would decline as a result of a rise in interest rates, resulting in lower stock prices.
Secured and unsecured debt offers account for a significant portion of mortgage REITs’ funding sources. In the event of an increase in interest rates, the value of a loan portfolio will decrease.
Most mortgage REITs trade at a discount to their net asset value per share in a low-interest-rate environment with the potential for increasing rates. In order to succeed, you must locate the proper one.
Income-Producing Real Estate: Simplified
In order to make it possible for anybody to hold income-producing real estate, Congress created REITs.
A REIT has a lot to offer investors in terms of diversity and past performance. Hopefully, our explainer has shed some light on how this financial instrument works.
Next, you’ll want to check out our finance section to learn more about how to include REITs into your portfolio.
