Ever thought to yourself, I’d love to invest in real estate, but I don’t want the headaches that come with slow-paying tenants and busted pipes? Well, thanks to Real Estate Investment Trusts, or REITs, you can capitalize on real estate without ever having to chase down a late payment or fix a leaky faucet. In this post, I’ll discuss the reasons you might consider investing in REITs and talk about the types of REITs you can invest in.
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Hollywood paints a glamorous picture of what it’s like to be a real estate investor. But here’s the reality: buying and managing real estate assets can be a pain. For example, I know over 100 real estate investors. Some have dozens of properties, and some have hundreds. And nearly all of them say it’s a headache.
Because they have to track down tenants, they have to collect payments, and they have to fix any problems that arise on the properties.
And those are just the headaches that come once they own the real estate. The difficulties start much earlier. Because before you can buy a rental property, you have to research the properties on the market, find one you like, and go through the pains of negotiating a purchase deal. And after that, you have to jump through the bank’s hoops to ensure you qualify for financing.
Then, if you decide to sell the property later, you’ll have to figure out the best way to structure the taxes, which opens up a whole other set of complications.
So you can see how investing in real property requires you to have a high threshold for pain—from start to finish.
But here’s the good news: there are ways to invest in real estate without purchasing physical assets, without the hassle of managing a rental property. One of the most common ways to do this is to invest in a Real Estate Investment Trust, or REIT.
A real estate investment trust, or REIT, is defined by the US Securities Commission as a group or corporation that pools money from investors to buy and manage income-producing real estate. For example, a REIT could buy and rent out office buildings, shopping malls, apartments, hotels, resorts, single-family residences, storage warehouses—any type of property that will produce recurring rental revenue.
In fact, REITs are often categorized by the types of real estate they invest in.
Each of these REITs purchases and manages properties as part of a long-term investment portfolio.
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In other words, REITs don’t buy properties with the intent to resell, or flip properties for a profit. Instead, they buy properties with the intention to rent them out for as long as possible. And that means investors get a steady dividend income along with some nice capital gains.
And since REITs are required by law to distribute at least 90% of their taxable income to shareholders, the dividends can be quite sizable. In fact, REIT dividends can be just as substantial as purchasing a physical real estate asset.
Imagine you bought a residential property for $100,000 and rented it out for $1,000 a month. You’d have a 12% yield, or dividend, on that rental property. (Here’s how the math breaks down: $1000 x 12 months = $12,000 per year, which is 12% of the $100,000 purchase price.)
But that 12% yield is the gross dividend—before taxes, insurance, repairs, maintenance, and depreciation are subtracted out. After take-outs, the actual profit could be anywhere from 4 to 9%.
On the other hand, the average return for REITs is 11.8%. That beats the 9.5% average for the S&P 500, the 9.6% average for international stocks, and the 8.1% average for government bonds.
So adding a REIT to your portfolio is worth considering for the high dividends alone.
Before you invest in a REIT, you’ll need to consider whether to buy a non-traded REIT or a publicly-traded REIT. Both require 90% of their taxable income to go to stakeholders, and both are total return investments with the potential for high dividends. But each is designed for different purposes and has its advantages and disadvantages.
Non-traded REITs, as their name implies, are sold by brokers instead of being listed on a public stock exchange. They’re designed to reduce or eliminate taxation returns, and they have strict holding requirements, sometimes up to 10 years. So they’re considered an illiquid investment.
Here are the two kinds of non-traded REITs you can choose from:
What are the upsides to investing in non-traded REITs?
Thanks to the fact that people aren’t trading them emotionally on the marketplace, you could have a potentially higher return than if you bought a publicly-traded REIT.
And, because they’re an illiquid investment, they have a relatively low correlation to equities and bonds. That means that if the market goes down, non-traded REITs typically go up and vice versa. Basically, non-traded REITs tend to zig and zag differently than other investments. And that makes them a great way to diversify your portfolio.
What are the downsides to investing in non-traded REITs?
Non-traded REITs can have upfront broker commissions as high as 16%.
Plus, you can’t quickly cash out of a non-traded REIT. If you need to exit your investment before a scheduled liquidation event, you’ll have to accept a loss—usually a big one.
Publicly Traded REITs are listed on an exchange such as the New York Stock Exchange or the NASDAQ. And, as with any stock, you can buy and sell a publicly-traded REIT with relative ease. So these are highly liquid investments.
What are the advantages of investing in publicly-traded REITs?
As I just mentioned, publicly-traded REITs are a liquid investment. In other words, there’s no requirement to hold onto a publicly-traded REIT for a long time. So if you put 10 grand into a traded REIT, then suddenly need to get your money back, you can turn around and resell it at market value.
Another advantage to traded REITs is that, like PNLRs, they have their securities registered with the SEC. So they have to submit to regulations and file regular financial reports. This can potentially make them a ‘safer’ (we know all investments have risk) investment for beginner real estate investors.
And unlike non-traded REITs, they have a low barrier to entry. You don’t have to be accredited to invest in them, and shares can start at less than $100.
What are the disadvantages of investing in publicly-traded REITs?
The most significant disadvantage is that traded REITs are subject to the unpredictable nature of the stock market. And even though the lower correlation to other stocks still makes these REITs a viable way to diversify, you also have to deal with daily market fluctuations.
So out of all the REITs we’ve discussed, which is best?
That depends on your investment goals, your personality, and your finances. I think there’s a place for all of them, depending on what you’d like to achieve.
Hopefully, this article has given you a good head start!
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Also, remember, this article is not a solicitation for a securities product. Please conduct your own due diligence or speak with your financial advisor to determine if you should consider REITs as part of your investment portfolio. This blog post is for educational and informational purposes only.