These investments let you own real estate without having to be a landlord.
What is a REIT? A real estate investment trust (REIT) is a real estate investment company that manages a portfolio of income properties, distributing the lion’s share of its profits as dividends. By getting into a REIT, you can gain an ownership interest in prime commercial real estate, without the headaches of commercial real estate management.
How do REITs work? On one level, a REIT is an agreement with the Internal Revenue Service. In choosing a REIT structure, a real estate investment company agrees to pay out 90% or more of its taxable profits in dividends in exchange for avoiding corporate income tax. (1)
The typical REIT is a public REIT, with investors buying shares in the trust. These shares are sometimes casually referred to as “real estate stock.” Like any other stock, a REIT stock offers you the potential for dividend income and share value appreciation.
REITs pay no corporate taxes, so their total returns can be impressive. For example, REIT Realty Income, a top net-lease retail REIT, has returned an average of 16.9% a year (including dividends) since its 1994 New York Stock Exchange debut. REIT Welltower, a prominent health care REIT, had its IPO back in 1971; since then, its yearly total return has averaged 15.6%. Regarding index performance, the NAREIT index of publicly traded equity REITs had an annualized return of 9.67% during 1997-2016, versus 7.68% for the S&P 500. (2)(3)
In addition to equity REITs, you can also explore mortgage REITs, which invest in home loans and mortgage-linked securities, and hybrid REITs, which invest in both real estate and mortgages. (4)
REIT dividends are usually paid out as ordinary income. Sometimes, though, a REIT may choose to categorize a dividend as a return of capital, which results in tax deferral and a lower taxable income for the investor during the period he or she holds the stock. That can boost the after-tax dividend yield. (2)(4)
Two other nice things about REITs are worth noting. They don’t pass tax losses on to investors, and they often have low investment minimum. (3)
Not all REITs are listed on stock exchanges. Some are non-traded. These REITs are akin to private equity funds – they are usually conceived to last for a certain number of years before either listing their shares, selling out, or liquidating. While their dividend yields may potentially surpass those of publicly listed REITs, non-traded REITs are also fundamentally illiquid until they liquidate or go public. Typically, assets directed into a non-traded REIT are out of an investor’s reach for seven years or longer. (5)
Are REITs right for your portfolio? Many investors are considering REITs these days, attracted by the diversification they provide for a portfolio. They can choose from REIT mutual funds, closed-end funds, and REIT ETFs, among other options.
Before you make the move to invest in a REIT, be sure to speak with a qualified financial advisor who knows the fine points of REIT investing and the risks involved.