REITs

REITs vs. Bonds: Which Investment is Better?

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REITs and bonds offer a consistent income stream but are two different types of investments.

REITs vs. Bonds

What Are REITs?

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating commercial real estate.

REITs can own or invest in properties like office buildings, apartments, hotels, shopping centers, and self-storage, to name a few. There are also mortgage REITs that provide financing for real estate by purchasing mortgages or mortgage-backed securities from banks and other originators.

REITs can be publicly traded or non-traded. Publicly traded REITs are easily bought and sold on a stock exchange like the NASDAQ or NYSE. Non-traded REITs are operated outside the public market and are subject to less regulatory oversight.

What Are Bonds?

Bonds are debt securities corporations, municipalities, or government entities issued to raise capital. When an entity issues a bond, it is essentially borrowing money from investors, who purchase the bonds in exchange for a promise of regular interest payments and the return of the principal (the amount invested) at the bond’s maturity date.

Bonds are considered fixed-income securities because they typically pay a fixed interest rate. The interest rate is determined by several factors, including the creditworthiness of the issuer, prevailing market interest rates, and the length of time until the bond’s maturity date.

Investors can buy and sell bonds on bond markets, and the bond prices fluctuate based on changes in interest rates and other factors that affect the issuer’s creditworthiness.

Bonds are often seen as a relatively safe investment compared to stocks because the interest payments and principal repayment are typically more predictable. However, there is still some risk associated with investing in bonds.

How are REITs and Bonds The Same?

Below, we explore the similarities between REITs and Bonds.

Passive Income

REITs and bonds are primarily for income-oriented investors and can be a good source of passive income.

Most REITs generate rental income from real estate properties, which can be a steady income stream, while bonds generate income through coupon payments.

Liquidity

Most REITs and Bonds trade are publicly traded, thus making them easy to buy and sell without significantly impacting the price of these securities.

Accessible to Retail Investors

Another similarity between REITs and bonds is that retail investors can easily access them through most online brokers.

Inflation Protection

Both REITs and bonds can offer some degree of protection against inflation. REITs can provide inflation protection because rental costs and property values tend to rise with inflation.

Meanwhile, bonds can also provide some inflation protection if they offer a floating rate bond where the rate is pegged to inflation, like Treasury Inflation-Protected Securities (TIPS).

Market Value Fluctuation

REITs and bonds can fluctuate in value based on market conditions. The market value of REITs can be affected by changes in interest rates, economic conditions, and real estate market trends.

Similarly, the market value of bonds can be affected by changes in interest rates, credit ratings, and the issuer’s financial health.

How Are REITs and Bonds Different?

While REITs and bonds can provide income to investors, they are fundamentally different types of investments.

Income Stream

REITs generate income from rental income and property sales, while bonds generate income from interest payments. REITs typically pay out a portion of their rental income as dividends to investors, while bonds may have a fixed rate or pay a benchmark rate such as SOFR plus a spread.

Tax Treatment

REITs are unique because they are required to distribute at least 90% of their taxable income to shareholders as dividends.

As such, REIT dividends are generally taxed at ordinary income tax rates, which are less advantageous than the qualified dividend rate.

Meanwhile, the taxation of bonds can vary depending on several factors, including the type of bond, the issuer of the bond, and the location of the bondholder.

Generally speaking, bond interest is subject to federal income tax and possibly state and local income taxes, depending on the jurisdiction. However, some types of bonds are exempt from certain taxes or have lower tax rates, such as municipal bonds issued by state or local governments.

Interest Rate Sensitivity

Another key difference between Bonds and REITs is interest rate risk.

Bonds are susceptible to changes in interest rates because they are usually fixed-income securities, meaning their value is directly affected by changes in the prevailing interest rates.

Bond Prices and Interest Rates have an inverse relationship. When interest rates rise, the yield on new bonds increases, which makes them more attractive to investors.

As a result, the price of existing bonds with lower yields decreases because investors can buy new bonds with higher yields instead. Conversely, when interest rates fall, the yield on new bonds decreases, which makes existing bonds with higher yields more attractive, causing their prices to increase.

Example:

suppose an investor purchased a bond with a 5% yield when the prevailing interest rates were 5%. If interest rates rose to 6%, a new bond with a 6% yield would become available, making the existing bond with a 5% yield less attractive to investors. To sell the bond, the investor would have to lower its price, thereby increasing its yield to compensate for the higher prevailing interest rates.

Stock Market Correlation

Publicly traded REITs tend to correlate highly with the overall stock market.

A correlation of 1 means a stock or sector moves precisely with the overall stock market.

According to a Morningstar.com analysis, the FTSE NAREIT Equity REIT had a correlation of 0.59 with the CRSP 1-10 U.S.Estate Market Index, which represents nearly 100% of the investable U.S. Equities Market.

So if the total stock market moves down 10%, the equity REIT market is expected to drop 5.9%.

Meanwhile, bonds tend to have a negative correlation with the stock market. Investment giant Schroders points out that bonds have a negative correlation of 0.35 with stocks.

If you are a buy-and-hold investor or can not stomach periods of extreme volatility, you may want to think twice before investing in the real estate market through REITs.

You might also be interested in Real Estate vs. Stocks.

Capital Stack Position

Within the capital stack, Most REITs are considered equity investments, meaning in the case of default, equity investors are the last to receive any money back. Meanwhile, bonds are considered debt investments, so in the case of default, bondholders will be entitled to any claims before equity investors.

When comparing REITs and Bonds, most individual investors don’t have to worry about default risk if they invest in an investment-grade bond ETF, which can help diversify their risk across bonds of different tenors and quality.

Maturity

When a Bond is issued, it has a fixed maturity, so at that maturity date, the issuer must return the total investment amount plus the accrued coupon. Meanwhile, REITs do not have a maturity date; REIT managers may buy and sell properties at their discretion, but there is no legally binding maturity date in most cases.

Performance & Yield

Let’s take a look at the historical performance of REITs vs. Bonds.

Historical Performance: REITs vs. Bonds

Over the long term, REITs have historically provided higher total returns than bonds.

According to Nareit, the total return of U.S. REITs from 1972 to 2020 was 9.5%, compared to the total return of U.S. bonds, which was 5.8% over the same period.

Dividend Yield: REITs vs. Bonds

REITs typically have higher dividend yields than bonds. According to Nareit, the dividend yield of U.S. REITs was 3.77% as of December 31, 2020, while the yield on the Bloomberg Barclays U.S. Aggregate Bond Index was 1.22% over the same period.

How to Incorporate REITs and Bonds In Your Portfolio

If you want to become an investor, it’s essential to have a well-diversified portfolio and choose the right type of bonds:

There are many types of bonds to choose from, including:

Corporate bonds, municipal bonds, and government bonds. Each type has its risk profile, so choosing the right kind of bonds for your portfolio is important.

  1. Consider bond funds: Instead of buying individual bonds, you can also invest in bond funds. These funds hold a portfolio of bonds, providing diversification and professional management.

  2. Determine how much to invest: As with any investment, it’s essential to determine how much you want to invest in bonds. A common rule of thumb is to allocate a percentage of your portfolio to bonds equal to your age. For example, if you are 30 years old, you might consider allocating 30% of your portfolio to bonds.

  3. Monitor your investments: As with any investment, it’s important to monitor your bond investments to ensure they continue to meet your investment goals and risk tolerance. You should also review your portfolio regularly and rebalance as necessary to ensure it remains diversified.

REIT Taxes

A Beginner’s Guide REIT Dividends Taxes

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Don’t Get Caught by Surprise Taxes: What You Need to Know About REIT Dividends and Tax Implications

Real Estate Investment Trusts (REITs) own or invest in income-producing real estate.

There are three typical REITs:

  • Equity REITs, the largest category, own and operate physical properties, like apartment building or even Self-Storage REITs.
  • Mortgage REITs don’t own or operate physical properties; these companies invest in mortgages and mortgage-backed securities. 
  • Hybrid REITs mix the two and may invest in mortgages while owning physical properties.

Regardless of the REIT type and its availability (publicly-traded or a non-traded REIT, the IRS considers REITs pass-through entities.

A pass-through entity is not subject to standard corporate income taxes. Instead, the income and cash flow are distributed directly to the shareholders, who are, in turn, responsible for the taxes on their share of the REIT’s taxable income.

To qualify as a REIT, these companies must legally distribute at least 90% of their taxable income to their shareholders as dividends. 

How Are REIT Dividends Taxed ?

There are two primary differences in REIT dividend taxation compared to other investable assets:

  1. REIT dividends are usually taxed at the ordinary income rate rather than as long-term capital gains.
  2. REIT dividends may include a portion of the investor’s return of capital (ROC).

Dividend Tax Rate 

REIT dividend taxes and those owed on typical stock dividends differ in that REIT dividends are generally taxed at ordinary income tax rate rather than as qualified dividends subject to a lower long-term capital gains rate.

That ordinary income rate, commonly known as your ‘tax bracket’ rate, is generally higher than qualified dividends. However, qualified dividends from a regular company’s excess earnings distributions are usually subject to the long-term capital gains tax rate.

In the United States, ordinary income tax rates range from 10% to 37%, whereas long-term capital gains tax rates range from 0% to 20% – the wide variance depends on your income level, so it’s best to touch base with your tax advisor to see what your specific situation demands.

REIT

Dividend Differences

For easiness’ sake, we’ll assume you’ve invested $10,000 in a standard stock (XYZ) and the same amount in a REIT; both distribute $500 annually as a dividend. 

We’ll say that the entire $500 dividend is qualified for your  XYZ investment. Qualified, in this case, means that it’s taxed at a long-term capital gains tax rate of 15%. Come tax time, you owe $75 on the dividend ($500 x 15%).

The entire $500 dividend for the REIT is ordinary income, so it’s taxed at your marginal tax rate, which we’ll peg at 25%. In this case, you owe $125 in taxes on the REIT dividend ($500 x 25%).

In this example, the tax on the REIT dividend is higher than the tax on your qualified dividend from XYZ because the REIT is legally required to distribute at least 90% of its taxable income to shareholders – cash flow generally considered ordinary income, so it’s taxed at higher rates.

REITs may receive a Return of Capital

REIT dividends are also subject to a unique tax treatment if a portion of the dividend is classified as a return of capital (ROC). 

ROC is a chunk of the dividend paid to REIT shareholders considered a return of their original investment instead of taxable income from the REIT’s operations. 

Although the ROC portion of the dividend isn’t subject to immediate taxation, it does reduce the investor’s cost basis in the REIT shares they own. Ultimately, when you sell your shares, the lower cost basis creates a higher return and demands higher taxes on those gains. 

There are several reasons why REITs might choose to issue a Return of Capital:

Tax efficiency

Since REITs are required by law to distribute at least 90% of their taxable income to shareholders annually, classifying a portion of the dividend as ROC helps investor defer taxation for as long as they own shares in the company. 

Cash flow management

REITs often use ROC to manage their cash flow. If a REIT sees a large capital expenditure on the horizon or is in the process of acquiring new properties, the REIT conserves cash to fund activities by returning capital to investors.

Investor preferences

Some investors prefer ROC over income-based dividends because it may be more tax-efficient. ROC also helps investors avoid taxes on “phantom income,” which sometimes happens when a REIT distributes more than its taxable income.

Suppose you invested $10,000 in a REIT and received $500 in dividends during the year. Of that distribution, $200 is classified as Return of Capital.

  • Amount Invested: $10,000
  • Dividends during the year: $500
  • Return of Capital: $200

Here’s how the ROC affects your taxes:

  • Taxable income: $300 ($500 total dividends – $200 ROC).
  • Adjusted cost basis: $9,800, because the $200 ROC drops your cost basis from $10,00 to $9,800.
  • Capital gains: $2,200. f you sell REIT shares later for $12,000, your capital gain calculations use  your adjusted cost basis of $9,800 istead of  the original $10,000 cost basis.

In this scenario, the ROC component of the dividend reduces your taxable income from the REIT dividends that year but increases your capital gains tax liability later when you trim the position or sell all shares. 

It’s important to note that this is a simplified example; specific tax implications of ROC and REIT dividends vary based on individual circumstances and the tax laws in your state or country.

PRO TIP: Not all REIT dividends include a Return of Capital component. The amount of ROC in REIT dividends can vary depending on the REIT’s financial performance and other factors.

1099-DIV Form

When a REIT generates dividends, the company sends a 1099-DIV form at the end of the year. 

This form shows the total dividends received, and breaks them down as ordinary income and return of capital, depending on the REIT’s distribution structure that period.

The Bottom Line

Although REIT investing can provide a steady income stream, it’s important to understand the tax implications of REIT dividends.

REIT dividends are typically classified as ordinary income and may include a portion classified as a return of capital. 

If  you’re in a high-income bracket, it may be worth considering moving to a dividend-paying stock with comparable yield to reduce dividend tax burden – especially if you’re investing in a taxable brokerage account.

Either way, consult with a tax professional to understand the tax implications of your REIT investments based on your circumstances.

Frequently Asked Questions

How are REIT dividends taxed if they are reinvested?

When you reinvest your REIT dividends, the tax treatment is the same as receiving the dividends in cash. This means that the reinvested dividends are still subject to taxes.

You are essentially using the dividends to purchase additional shares of the REIT. The value of these additional shares is equivalent to receiving cash dividends, and you must pay taxes on the value of the additional shares.

Are REITs Taxed Twice?

Real Estate Investment Trust (REIT) dividends are not taxed twice but are subject to different tax rules than dividends from regular corporations.

Unlike regular corporations, REITs do not pay corporate taxes on their earnings. Instead, the tax burden is passed to shareholders through taxes on the dividends received.

So, while REIT dividends are subject to taxation at the individual level, they are not taxed twice since the REIT itself does not pay corporate taxes on its earnings.

Self Storage REIT

Self-Storage REITs: A Beginner’s Guide To Investing in 2024

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Unlock the storage of wealth with self-storage REITs, the booming real estate investment that offers the potential for high yields, low volatility, and recession-resistant returns.

This article explores a unique Real Estate Investment Trust (REIT) sector: self-storage real estate. The self-storage market exploded over the last decade. Experts expect the sector to grow nearly 32%, to  53.92 billion customers, by 2026.

If you’re interested in real estate investing and considering physical real estate vs. REITs, then self-storage may be a good opportunity for your portfolio.

What Are Self Storage REITs?

Self storage REITs are a specialty sector of the Real Estate Investment Trust market that own and operate storage facilities and rent space to individuals and businesses.

Self storage REITs generate income by collecting monthly rent from their customers. The storage facility can also appreciate, further generating wealth for its owners through the disposition of this asset.

Advantages of Self Storage REITs

Self storage REITs offer many significant advantages over other investments, such as generating passive income, low building and operating costs, and strong demand in an up or down economy.

Generate Passive Income

One of the most significant advantages of self storage REITs is their ability to generate strong dividend yields for their investors. 

As of this writing, the average dividend yield for self storage REITs is around 3.5%, according to Nareit, a trade organization for REITs.

Meanwhile, the S&P 500, a stock market index that tracks the performance of 500 large-cap U.S. companies, has an average dividend yield of around 1.3%, thus highlighting an attractive opportunity for income-oriented investors.

Low Building and Operating Costs

Another advantage of self storage REITs is their low construction and operating costs. 

With storage REITs, there are no expensive brick veneers to build or broken toilets to fix.

To further highlight how self storage REITs are reducing operating costs is their increasing adoption of automation technology. Many self storage operators are fully or partially automating their properties. Adopting automation can significantly increase the net operating income of a self storage REIT.

A Cushman & Wakefield white paper on self storage highlights that automation can reduce the need for an onsite property manager, saving a storage operator upwards of $60,000, thus increasing the property’s net operating income.

Strong Demand in Up or Down Market

Lastly, another key advantage of self-storage REITs is their demand resiliency. Consumers need and demand self storage units whether the economy is in an upturn or a downturn – a characteristic largely unique to the self storage business.

For example, when the economy is in a downturn, people downsize. Downsizing often requires rental space to store belongings that can no longer fit in their home or apartment.

When the economy is prospering, consumers commonly purchase more items than they can keep in their homes. And utilizing their extra income, consumers will likely rent a self storage unit to store their extra possessions.

Investing
According to the Self Storage Association, the self storage market is expected to grow nearly 32% to a 53.92 billion market in 2026.

Risks of Self Storage REITs

Self-storage real estate investment trusts (REITs) have some risks like any investment. Here are some potential risks to consider before investing in self storage REITs:

Regulatory Risk

Self storage REITs are subject to regulations related to zoning, building codes, and environmental issues. Changes in laws could impact the ability of self storage REITs to operate or expand their facilities, which could affect their profitability.

Limited diversification

While self storage REITs invest in properties across different geographic locations, they are still primarily focused on a single asset class. This lack of diversification may not be suitable for all investors looking to diversify their portfolios across multiple asset classes.

Potential for Oversupply

Because self storage has low building and operating expenses, and therefore fewer barriers to entry 5han apartment REITs, self storage REITs run the risk of oversupply, i.e., more self storage space than there is demand. 

How To Evaluate Self Storage REITs

Here are some key factors to consider when evaluating self storage real estate investment trusts (REITs):

Occupancy Rates

Occupancy rates are among the most important metrics for evaluating self storage REITs. This indicates the percentage of units that are currently rented out. A high occupancy rate suggests that the REIT successfully attracts tenants and manages its properties effectively.

Rental Rates

Rental rates are another important factor to consider. Higher rental rates generally indicate a strong demand for storage units and a competitive market position.

Geographic Diversification

It’s important to evaluate the geographic diversification of the REIT’s portfolio. A REIT with properties in multiple locations can help mitigate risks associated with localized economic or regulatory changes.

Property Quality

The quality of the REIT’s properties can impact its competitiveness in the market. Look for properties that are well-maintained, secure, and have modern amenities.\

Financial Performance

Review the REIT’s financial performance, including revenue, net income, and funds from operations (FFO), a key metric for evaluating REITs. A history of strong financial performance can indicate a well-managed and financially stable REIT.

Management Team

The experience and track record of the REIT’s management team can also be an important factor. Look for a management team with a proven history of success in the self storage industry.

Valuation

Lastly, evaluate the valuation of the REIT relative to its peers and the broader market. Consider factors such as the price-to-earnings (P/E) ratio and dividend yield.

Popular Self Storage REITs

If you are interested in self storage, below are some of the most popular publicly-traded self storage REITs.

  1. Public Storage (PSA): Public Storage is the largest self storage REIT in the United States, with over 2,500 facilities in 38 states. The company was founded in 1972 and has a market capitalization of over $47 billion as of September 2021.
  2. Extra Space Storage (EXR): Extra Space Storage is the second-largest self storage REIT in the United States, with over 1,900 facilities in 40 states. The company was founded in 1977 and has a market capitalization of over $21 billion as of September 2021.
  3. CubeSmart (CUBE): CubeSmart is a self storage REIT that operates over 1,200 facilities in 38 states. The company was founded in 2004 and has a market capitalization of over $9 billion as of September 2021.
  4. Life Storage (LSI): Life Storage is a self storage REIT that operates over 950 facilities in 34 states. The company was founded in 1982 and has a market capitalization of over $7 billion as of September 2021.
  5. National Storage Affiliates Trust (NSA): National Storage Affiliates Trust is a self storage REIT that operates over 800 facilities in 35 states. The company was founded in 2013 and has a market capitalization of over $5 billion as of September 2021.

These self storage REITs have grown in popularity due to the growing demand for self storage units and the stable income generated by renting out these units monthly. They offer investors a way to invest in real estate without buying property.

The Bottom Line

Self storage REITs can be a good investment option for income-seeking investors and those looking to diversify their portfolio with exposure to the real estate sector.  

Self storage REITs also offer the potential for long-term growth and diversification in a portfolio. However, as with any investment, it’s important to conduct thorough research and seek the advice of a financial professional before making any investment decisions.

Mortgage REIT Guide

2024 Guide To Investing In Mortgage REITs

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Maximize Your Investment Returns: Your Ultimate Guide to High Yield Investing in Mortgage REITs and ETFs.

What Are Mortgage REITs?

Mortgage REITs (mREITs) are a type of Real Estate Investment Trust that invests in mortgages and mortgage-backed securities (MBS). Their unique structure makes them a good alternative to buying a rental property.

Mortgage REITs offer financing for real estate by purchasing mortgages or mortgage-backed securities from banks and other loan originators.

mREITs offer a simple way to hold an equity investment in the mortgage market with the liquidity and transparency of publicly traded equities. These unique advantages aren’t typically available through direct investments in mortgage loans and mortgage-backed securities.

Mortgage REITs provide a critical economic function by facilitating the housing market. According to REIT.com, mREITs help finance 1 million U.S. homes. Ultimately, mortgage REITs provide liquidity to the mortgage market by buying mortgages and mortgage-backed securities, making it easier for homeowners and businesses to obtain mortgages.

How Do Mortgage REITs Work?

Mortgage REITs work differently than traditional real estate investments. mREITs do not own any physical real estate like traditional Equity REITs. Instead, mortgage REITs invest in mortgages and mortgage-backed securities issued by banks and other institutions.

Mortgage REITs use the money raised through short-term debt securities like repurchase agreements (repos) or common/preferred equity offerings to finance the purchase of their investments.

Mortgage REITs rely heavily on borrowing, so the difference between the cost of raising financing and the interest earned on their investments is their net interest margin, which is the primary way mortgage REITs make money.

How Do Mortgage REITs Make Money?

Mortgage Real Estate Investment Trusts (mREITs) make money through interest and capital appreciation on their investment, not through rental income like equity REITs.

Interest income: mREITs earn income by collecting interest payments and MBS they hold. They typically invest in mortgages with higher interest rates than they pay on the cost of financing they use to fund these investments.

Capital appreciation: mREITs may also appreciate if interest rates fall, leading to an increase in the value of the underlying mortgages and mortgage-backed securities.

Mortgage REITs help finance 1 million homes in the U.S., according to REIT.com.

How Do Interest Rates Affect Mortgage REITs?

Because mortgage REITs do not own physical real estate property, the rise and fall of interest rates can significantly impact the value of mREITs.

mREITs tend to benefit from low-interest rate volatility because it reduces prepayment risk, and there is a large spread between borrowing costs and the rate they can earn in the market.

It’s important to note that the effect of interest rates on mREITs can be complex and is not always straightforward.

Convexity

Mortgage REITs, specifically mortgage-backed securities, are subject to a statistical concept called convexity.

Put simply; convexity means the value of an MBS security will increase or decrease non-linearly compared to a treasury bond of similar maturity.

Spread Compression

mREITs also make money by earning a spread between the interest they earn on their mortgage assets and the interest they pay to service their debt. 

Most mortgage REITs rely on short-term financing but hold long-term investments.

So, when interest rates rise, their cost of financing will increase, but the rate of return on their investment will be static, thus compressing their spreads and decreasing profitability.

Refinancing

Another way interest rates affect Mortgage REITs is through refinancing. As interest rates fall, borrowers may be more inclined to refinance their mortgages at lower rates. 

This can lead to prepayments and early repayment of the mortgages, which will impact the value of mortgage-backed securities.

Leverage

mREITs often use leverage,  borrowing money to invest in mortgages and mortgage-backed securities.

When interest rates rise, the cost of borrowing also increases, which can negatively impact the mREIT’s profitability.

For example, mREITs may use hedging or other strategies to mitigate the impact of interest rate changes on their portfolio. If executed correctly, hedges should offset any gains or losses due to changes in interest rates.

PROs and CONs

Pros of Mortgage REITs

  • High dividend yields: mREITs often pay high dividends, providing investors with a steady income stream.
  • Potential for capital appreciation: mREITs may also appreciate if interest rates fall, leading to an increase in the value of the underlying mortgages and MBS.
  • Diversification: mREITs can provide a way to diversify a portfolio with exposure to real estate without the need to buy and manage the physical property.

Cons of Mortgage REITs

  • Interest rate risk: mREITs are sensitive to changes in interest rates, and their value can decrease if interest rates rise.
  • Credit risk: mREITs are exposed to the credit risk of the borrowers whose mortgages they hold, and if many borrowers default, the value of the mREIT could be negatively affected.
  • Leverage: mREITs often use leverage to increase their returns, which can amplify the effects of interest rate changes and credit risk, but also increases the risk of loss.
  • Less control: Unlike rental property, mREITs investors have less control over the properties or mortgages they invest in.

How To Invest in Mortgage REITs

There are several ways to invest in Mortgage Real Estate Investment Trusts.

Purchase shares of an mREIT through a traditional brokerage

Many mREITs are publicly traded companies, and their shares can be easily purchased through a brokerage account, just like any other stock. 

This is the most common and easiest way to invest in mREITs.

Invest in a REIT ETF or REIT Mutual Fund

There are several mortgage-focused REIT ETFs and Mutual Funds. Investing in an ETF or Mutual Fund can provide a more diversified exposure to the mREIT sector.

REITs and mutual funds are good options for those who want to diversify their holdings or don’t want to avoid picking a single mREIT.

Invest in a private placement

Some mREITs may offer private placement opportunities to accredited investors.

Private placements are not publicly traded and usually have less stringent reporting requirements. However, they typically have high minimum investment and are difficult to buy or sell compared to publicly traded mREITs easily.

Who Should Invest in Mortgage REITs?

Mortgage REITs can be a suitable investment for certain investors.

Here are some characteristics of investors who may be well-suited to consider investing in mREITs:

Mortgage REITs are good for…

  • Investors who are comfortable with higher risk. mREITs are considered higher-risk investments due to their sensitivity to interest rate changes and credit risk.
  • Investors looking for high yield. mREITs often pay high dividends, providing a steady income stream for investors.
  • Investors looking for diversification. mREITs can provide a way to diversify a portfolio with exposure to real estate without the need to buy and manage the physical property. 

Mortgage REITs are NOT good for…

  • Investors who prefer a more diversified portfolio. Some mortgage REITs may have a high concentration of investments in a specific type of mortgage or geographic region, which can increase the risk of loss if that market or sector experiences a downturn.
  • Investors who can’t monitor market conditions, trends and interest rate movements as they are more likely to be affected by changes in interest rates.

Largest Mortgage REITs

Some of the largest publicly traded mortgage REITS include:

  • Annaly Capital Management Inc (NLY)
  • AGNC Investment Corp (AGNC)
  • Starwood Property Trust Inc (STWD)
  • New Residential Investment Corp (NRZ)
  • Blackstone Mortgage Trust Inc. (BXMT)

The Bottom Line

Mortgage REITs present an interesting investing opportunity.

Individuals should consider how adding mREITs would impact their overall diversification and risk of the portfolio.

It is essential to conduct thorough research and fully understand the advantages and risks before investing in mREITs.

Learn more about REITs: Read our Ultimate Guide to Investing in REITs.

Real Estate

Real Estate Syndication vs. REITs: Key Differences You Need To Know

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Real estate syndication is the high-stakes game of poker, while REITs are like playing a game of blackjack with the dealer – both may have their rewards, but the level of control and potential returns differ drastically.

Real Estate

What is a Real Estate Syndicate?

A real estate syndicate is a group of investors who collectively pool money to purchase a single investment property like a multi-family apartment complex, retail space, or warehouse.

A real estate syndicate is built on the back of sponsors who manage the project operations, and investors who kick up project funding.

Sponsors are often real estate investment companies who gather teams specializing in identifying opportunities and managing property operations, aiming for above-market returns.

Investors are critical to the syndicate’s operational success because they provide most of the capita;. The proliferation of the internet and real estate crowdfunding make networking between sponsors and investors much easier, ultimately bridging the gap between idea and execution.

Syndicates can be as small as two investors, but the largest options may have hundreds of investors.

A primary advantage to leveraging a real estate syndicate is that it helps investors to purchase a piece of real estate that would not have been possible individually. This piecemeal approach makes real estate syndicates attractive to real estate opportunists no matter their initial capital availability.

What is a REIT?

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating commercial real estate.

REITs often specialize in one specific sector like apartment complexes, hotels, shopping malls, timberland, and office buildings.

Most REITs are publicly traded and are easily bought and sold on a stock exchange like the NASDAQ or NYSE. There are also non-traded REITs that operate outside the public market and are subject to less regulatory oversight.

Either way, in order for a company to qualify as a REIT, they’re required by law to distribute at least 90% of its taxable income to shareholders as dividends. This income-driven approach makes them an attractive investment for investors who prefer regular cash flow but finds bonds boring.

Key Differences

If you are contemplating investing in REITs or a real estate syndicate, there are 8 key differences between these two investment options.

1. Liquidity

The biggest difference between real estate syndications and REITs is their respective liquidity.

Liquidity is how easily shares or ownership are bought and sold without impacting the price of an asset.

Because most REITs are publicly traded, their securities are usually easily bought or sold at a fair market value without impacting the security’s price.

Meanwhile, since investments in real estate syndications aren’t publicly traded, they offer almost no liquidity. For you as an investor, this means you cannot easily or quickly sell your investment in a syndicate.

Liquidity should be a significant consideration if you need to sell your investment in fewer than 3 – 5 years.

2. Minimum Investment

Another key difference between real estate syndications and REITs is the initial capital requirement.

You can easily invest in a REIT through traditional brokerages like TD Ameritrade, buying a stake in the company for as little as one share’s price.

Meanwhile, most real estate syndications have large investment minimums ranging from $25,000 to $100,000. A real estate syndicate’s average minimum investment is typically around $50,000.

The amount of money required to invest in a syndicate may be a significant barrier to entry when evaluating them against REITs.

3. Ownership Structure

Since real estate syndicates aren’t publicly traded, their ownership structure differs greatly from REITs.

When you invest in a syndicate, you have direct ownership in the real estate asset because you become a limited partner (LP) within the limited liability company (LLC) that owns the investment. 

Investing as an owner in real estate syndication is a significant advantage because it provides access to tax benefits only available through direct ownership.

REIT investors don’t have direct ownership in the firm’s real estate assets; instead, they have a stake in the company’s stock which provides no tax benefits.

Investors in Real Estate syndicates can benefit from depreciation tax benefits.

4. Diversification

Diversification is another notable difference between REITs and real estate syndication. 

Syndicates typically fund a single acquisition like a retail office building, a warehouse, or an apartment complex. This means your investment and the associated risks are embedded and concentrated within a single asset and subject to greater risk.

On the other hand, REITs invest in multiple assets within a specific sector which provides immediate diversification.

Diversification is a key component to building a well-positioned and thoughtful investment portfolio.

5. Barriers To Entry

Real estate syndications have significant barriers to entry compared to REITs.

Income and Net Worth Requirements

Most real estate syndications require investors to qualify as accredited investors, which imposes a minimum income requirement of $200,000 or a net worth of at least $1,000,000, not including your main residence.

High Minimum Investment

Real estate syndicates have minimum investments starting around $25,000, thus creating a significant barrier to entry for real estate investors.

Finding high-quality syndication opportunities can be difficult

Lastly, there is no open marketplace where you can download a list of all investments, like with REITs. Real estate syndication structuring is still largely done by word-of-mouth.

6. Tax Advantages

Investing in a real estate syndicate can offer significant tax advantages unavailable to REIT investors. 

With a syndicate, your investment may distribute taxable passive income. But, as an owner in the asset, your investment may qualify for depreciation benefits that offset most, if not all, of your distributed cash flow.

Generally speaking, syndicate investors write off a portion of income to account for the natural deterioration of the property and its effects on the property value over time. This ultimately lowers the amount of taxes you pay on your ordinary income.

Depreciation Example:

  • Property Value: $1,000,000
  • Useful Life: 39 years
  • Depreciation: $1,000,000/39 = $25,000 approximately
  • You can deduct $25,000 as depreciation expense for each year for 39 years on a pro-rata basis.

7. Due Diligence

Performing due diligence on a real estate syndication deal and the sponsor of the deal is much more time consuming than researching REITs.

Since real estate syndicates aren’t publicly-traded, they’re exempt from most SEC registration and reporting requirements.

This lack of oversight means there is limited financial data about the syndicate’s acquisitions and history that investors can easily access.

Meanwhile, because real estate investment trusts are usually publicly traded, they are subject to stringent reporting requirements. With a few clicks, you can easily find independent research analysis, financial reports, performance history, and details about the REIT’s strategy and management.

8. Investment Options

REITs offer a wide range of easily accessible investment options compared to real estate syndicates.

As of this writing, over 225 publicly-traded REITs trade on major stock exchanges and represent a combined market capitalization of $1 trillion. 

These REIT offerings invest across all sectors of the real estate industry, from Mortgage REITs, to timberland REITs, and even self storage – all easily available and at investors’ fingertips.

Meanwhile, investing through syndicates can still be a word-of-mouth process. For example, if you’re keen on timberland, finding a real estate syndicate in the field is much more difficult.

Which Is Better?

Real estate syndicates and REITs have varied advantages and disadvantages, depending on your needs.

As an investor, it’s important to consider your risk tolerance, financial status, investment horizon, investing goals, and how these considerations complement the unique features both syndicates and REITs offer.

Real Estate Syndications are good for…

  • Investors who are comfortable locking up their money for at least 3 -5 years
  • Want tax benefits through direct real estate ownership
  • Individuals who have at least $25,000 to invest

REITs are good for…

  • Investors who need liquidity; may need to sell their investments in less than 3 years.
  • Those who do not have a significant amount of capital to invest
REITs vs. Real Estate

REITs vs. Real Estate: Which Investment Is Better?

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REITs vs. Real Estate: Which Investment Will Win the Battle for Your Wallet?

REITs vs Real Estate

Real estate is the third largest asset class, behind stocks and bonds, and the most popular alternative investment by a long shot – it’s easy to see why. 

With consistent appreciation and investment potential, and often income-generating when leased or rented, real estate is a sound addition to any portfolio. 

Most beneficial, to many investors, is real estate’s diversification potential because diversification is a critical part of any investing strategy. 

But many new investors find themselves torn between the many options, wondering: is it better to invest in real estate or a REIT?

REITs and Real Estate: How they are the same

Inflation Hedge

Both real estate and REITs provide an inflation hedge to help maintain your capital’s purchasing power. As inflation increases, real estate and REIT managers often increase rent and lease costs to keep pace. A study by industry giant Nareit backs up that thesis, demonstrating that REIT dividend increases outpaced inflation for 18 of the last 20 years – between 2000 and 2020, REIT dividend annual growth was 9.4%, compared to a 2.1% inflation rate measured by Consumer Price Index.

How Are They Different?

Capital Requirements

REIT investments require FAR less capital than buying real estate outright. You can buy shares of Vanguard’s flagship REIT ETF, VNQ, for around $80 a share. With only $500, you can still get a piece of many properties. 

On the other hand, if you put down a measly 5% on a rental property, you’re still facing a hefty $20,000 bill – assuming an average duplex cost of around $400,000.

Liquidity

REITs also enjoy substantial liquidity benefits over typical real estate offerings. You can easily buy and sell your REIT shares without limitations, much like any other stock in your portfolio.

But flipping real estate on the open market is tough, and doing so quickly is nearly impossible. In real estate terms, “quick sales,”  funds sit in escrow for as much as 45 days… if all goes according to plan! In the end, cashing out a property sale can take between 75 – 180 days.

Management

REITs are professionally managed, with a team of experts behind the scenes acquiring, financing, and managing the properties in your portfolio. Physically owning real estate requires constant hands-on management by you, the owner. Alternately,  you can outsource to a management company but that’s going to eat into your profits and still demand far more of your time than a REIT.

Ultimately, with real estate, you’re responsible for all decisions related to the property including repairs, improvements, rent increases, and inevitable tenant disputes.

Investor Control

On the other hand, if you invest directly in real estate, you’re in charge of all decisions ranging from capital improvements to what color you should paint the bathroom and how much to charge for rent.

Meanwhile, when you invest in a REIT, you have basically no say in the REIT’s strategic direction, and all decisions are left to the management team.

Diversification

REITs offer greater diversification options compared to real estate investments. When you invest in an individual REIT or REIT ETF, you can easily diversify across multiple sectors of the overall industry. Meanwhile, diversification across multiple real estate sectors for individual investors is difficult, expensive, and compounds the management problem.

Leverage

Another critical difference between REITs and direct real estate investment is leverage. When you buy real estate, you can use borrowed money to amplify your returns but generally cannot use comparable leverage when buying publicly-traded REITs.

Sure, you can use margin loans and introduce leverage when investing in REITs, but margin loans are far more expensive than a mortgage and introduce a new level of risk. 

The average margin loan ranges between 8 -12% with big name brokers, with preferred rates usually set aside for clients with $1,000,000 or more in assets. Margin loans also cannot be amortized over 30 years like a mortgage.

Meanwhile, the 30-year fixed mortgage is around 6.50% as of this writing, making it substantially cheaper to attain leverage through a mortgage.

Let’s take an example to illustrate the power of leverage using Cash on Cash Return,  which is your pretax cash flow (after all operating expenses) divided by money invested.

If you put 25% down, your cash-on-cash return would only be 8% whereas, with 10% down, you hit 20%.

That is the oft-overlooked power of leverage in real estate investing.

Volatility

Since many REITs are publicly traded, they’re subject to overall market gyrations and related volatility.

Meanwhile, since real estate is illiquid and cannot be easily bought or sold, property valuations tend to be more stable than REIT pricing.

One quick note about volatility: many people argue that lower volatility in REITs is a myth because of the way real estate is priced.

It’s partially true.

You only know the price of your real estate when it’s marked to market (and even then, only for certain when it is eventually sold) but you know the price of your REIT every second that the stock market is open.

If you had REIT-like price transparency on your real estate, many argue it would be as volatile as the stock market, if not more – possibly, but maybe not.

The reality is that you can’t get REIT-like transparency on your real estate and, until that happens, the argument for reduced volatility in real estate will continue to hold true despite what any myth busters may say.

Correlation

Real estate is less correlated to the overall stock market than publicly traded REITs.

A correlation of 1 means a stock or sector moves exactly with the overall stock market.

According to Morningstar analysis, the FTSE NAREIT Equity REIT has a correlation of 0.59 with the CRSP 1-10 U.S.Estate Market Index, which represents nearly 100% of the investable U.S. Equities Market.

So, in other words, if the total stock market moves down 10% you can reasonably expect the equity REIT market to drop 5.9%.

Some also say the correlation argument is a myth which, again, is only partially true.

Real estate prices are a lagging indicator, which means their values tend to change after other economic indicators like inflation and interest rates go live.

If unfavorable economic data comes out, REITs prices usually react immediately. Meanwhile, real estate prices remain static because the trickle-down effect takes time to reflect in the property market.

Some claim that if you look only at REIT prices annually using an average price, you’ll see less correlation. 

But that’s simply a thought experiment, and the reality is that REIT prices don’t lag and don’t use average prices – so it’s a weak argument.

Transaction Costs

Another substantial difference between REITs and real estate are transaction costs. Buying and selling REITs through most online brokers like M1 Finance comes with no transaction cost when buying or selling REITs. Meanwhile, buying real estate comes with huge transaction costs.

Purchasing or selling a property often comes with closing costs around 3 -6% of the property purchase price. With a national average of a duplex of about $388,000, you’re facing nearly $11,500 – $23,000 in closing costs alone.

In numbers terms, the Vanguard VNQ REIT ETF trades at around $75 a share historically. Assuming the closing price is 6% of $388,000, you’re looking at $23,000 in closing costs.

That means you could have bought approximately 300 shares of VNQ, yielding a dividend return of around 4.2%, so you’re effectively giving up almost $1,000 in annual income distributions from paying closing costs.

PROs of Real Estate

Passive Income

REITs are truly passive income opportunities. A significant advantage to REIT investing is the generating passive income. Investing in REITs doesn’t demand tenant management, maintenance, insurance, or unexpected expenses which makes them a passive income strategy.

As of this writing, according to Motley Fool, the average dividend yield for Equity REITs is 4.3%. Some REITs pay significantly more, depending on their investment strategy and structure.

If you invested $10,000 in REITs, you could reasonably expect to earn $430 annually in dividends. Meanwhile, the S&P 500’s dividend yield is approximately 1.4%.

Tax Deductions

Generally speaking, real estate investors deduct normal maintenance expenses of properties, as well as other large expenditures.

Common tax deductions include mortgage interest, property taxes, operating expenses, depreciation, and repairs.

Most owners can deduct expenses for keeping their rental property in good operating condition; for example, certain materials, supplies, repairs, and general maintenance are often deductible.

Tax deductions can help make a questionable investment property more appealing to real estate investors.

You Can Build Equity

Equity in physical real estate is the difference between the property’s value and what you owe on the mortgage loan. Home equity is, in a way, essentially a “forced savings” long-term wealth building strategy.

While many can argue that you can generate greater returns investing in the stock market, the “forced savings” of homeownership is still middle America’s best financial asset according to the Brookings Institute.

And, while this article is directed toward investment properties rather than primary residences, the concept still applies.

You Own A Physical Piece of Real Estate

For many owners, there’s a unique sense of pride in owning physical real estate.

Real estate is tangible.

You can touch it. Walk through it. Paint it. 

You have total creative control.

Owning physical real estate is a much different experience than seeing a bunch of numbers on a screen and cannot be replicated through REIT investing.

Leverage

Unless you’re a professional investor or money manager, there aren’t many options to borrow large sums of money at a reasonable interest rate compared to mortgage lending, like we saw in our cash-on-cash example.

To reiterate, if you put 25% down, your cash-on-cash return would only be 8%. Meanwhile, if you put 10% down, your cash-on-cash return would be 20%.

CONs of Real Estate

Investing directly in real estate costs time and effort.

You must deal with tenant issues, maintenance, and imminent liability if an accident occurs. Finances are another thorny issue. Investors must borrow to purchase a property and are thus beholden to prevailing market interest rates.

There are other downsides, too:

Property Maintenance

Owning physical real estate means there are unavoidable maintenance costs. If you’re unable or unwilling to manage the property yourself, you may need to hire a property management company. Property management companies charge 8% – 12% of your monthly rental income. That certainly isn’t chump change.

It’s important to note that a property management company doesn’t include the cost of repairs, but rather serve an oversight and managerial function, so you’re still on the hook for peripheral costs.

Closing Costs

Buying a rental property or any piece of property is expensive. According to Zillow.com, closing costs average between 2% – 5% although they vary regionally.

For example, if you buy a $500,000 rental property, you can expect to pay between $10,000 and $25,000 in closing costs.

Standard closing costs usually include:

  • Application Fee
  • Appraisal
  • Lender’s Title Insurance
  • Loan Origination Fee

Most individuals lump closing costs into their mortgage payment, and it’s usually the buyer paying most of the expenses. Still, be sure to research and consider closing costs before deciding if physical real estate is right for you.

Tenant & Liability Risk

When you own rental property, there’s always the risk that something catastrophic could happen, leading to lawsuits based on negligence or if you’re renting to an ambulance-chasing tenant.

According to a recent article, rental property insurance is about 25% more expensive than traditional homeowners insurance. The latter costs approximately $1,445, so you can expect to pay about $1,800 annually for rental property insurance which, again, eats into your investment property cash flow.

Mortgage Interest

The interest rate you get on your mortgage can impact your monthly payment and income if you plan on running a rental property.

Most people can deduct mortgage interest on their taxes, but it’s not a 1-for-1 transaction. Some experts also note that home prices and mortgage rates have an inverse correlation, although that’s an imperfect comparison because there are many variables at play.

As of this writing, the average 30-year fixed mortgage rate, a common benchmark for borrowing, is over 5%. Historically, mortgage rates are still near all-time lows, but a 1% move in rates can drastically impact your monthly payment and cause wild swings in the housing market.

Property Taxes

High property taxes means your money is invested locally, making it a more desirable place to live which, in turn, raises property values.

But the benefits of a desirable location aren’t always immediately seen, although you definitely notice the property tax bill coming in each year – that’s why we’re marking property taxes as a drawback to real estate investing.

You can use this property tax calculator to estimate local property taxes.

PROs of REITs

Passive Income

REITs are truly passive income opportunities. A significant advantage to REIT investing is the generating passive income. Investing in REITs doesn’t demand tenant management, maintenance, insurance, or unexpected expenses which makes them a passive income strategy.

As of this writing, according to Motley Fool, the average dividend yield for Equity REITs is 4.3%. Some REITs pay significantly more, depending on their investment strategy and structure.

If you invested $10,000 in REITs, you could reasonably expect to earn $430 annually in dividends. Meanwhile, the S&P 500’s dividend yield is approximately 1.4%.

Less Capital Required

Investing in REITs requires MUCH less capital. You can buy shares of Vanguard’s VNQ REIT ETF for around $80 a share. So even if you only had $500 or $5,000 you could still invest in real estate through REITs.

Less Stress

A significant  but hard to quantify benefit to REITs is their stress reduction, since they’re  truly a passive income investment.

REITs will never call you at 3 a.m. to fix a leaky faucet.

There is no risk of tenants not paying on time, a water pipe bursting, or neighbors complaining.

Liquidity

The most significant benefit to publicly traded real estate investment trusts is that you can easily buy and sell your shares with no limitations. Unlike owning physical real estate, you cannot easily or quickly buy or sell a property – there’s much less liquidity in the market compared to REITs.

Liquidity should be a primary consideration if you plan on holding your investment for fewer than five years.

Low Transaction Costs

Investing in publicly-traded REITs is cheap. Big-name brokerages like TD Ameritrade or Fidelity often offer zero or low brokerage costs, so you can easily buy and sell REITs without large peripheral expenses.

Meanwhile, purchasing real estate often comes with closing costs of 3 – 6% of the property purchase price.

CONs of REITs

REITs are an attractive way to diversify your portfolio through exposure to the real estate market.

But there are some issues to consider. There are no tax breaks like you’d enjoy investing in physical real estate. You also have no artistic control.

Stock Market Correlation & Volatility

Publicly traded REITs tend to correlate highly with the overall stock market. A correlation of 1 means a stock or sector moves exactly with the overall stock market.

According to a Morningstar.com analysis, the FTSE NAREIT Equity REIT had a correlation of 0.59 with the CRSP 1-10 U.S.Estate Market Index, which represents nearly 100% of the investable U.S. Equities Market.

So if the total stock market moves down 10%, the equity REIT market can be expected to drop 5.9%.

And, if you’re a buy-and-hold investor or can’t stomach periods of extreme volatility, you may want to think twice before investing in the real estate market through REITs.

Capital Gains Tax

If you sell your REITs for a profit, you’re subject to either short- or long-term capital gains taxes.

Long Term Capital Gains kick in when an investment is held for a year or longer. The tax rate can range between 0% and 20%, depending on your income.

Short Term Capital Gains apply if an investment is held less than a year. The rate is your ordinary income tax rate, ranging between 10% and 37%.

Capital gains taxes are generally unavoidable in any investment situation, and you would also have to pay taxes if you sold your investment property. The exception is when you execute a 1031 Exchange, if eligible, which lets you defer capital gains by swapping one real estate investment property for another.

No Investor Control

When you invest in a REIT, you don’t have control of the investment strategy. Sure, you can put your money towards a REIT that executes a particular strategy or invests in a certain property type, but you don’t have any direct say in how and when that strategy is executed.

Meanwhile, directly investing in real estate, you’re in control of all aspects. You manage all decisions, from property improvements and how much to charge for rent, all the way down to individual tenant screening.

Are REITs better than Real Estate?

Real estate investment through physical real estate or REITs can be beneficial for your investment portfolio, but you need to narrow down which strategy works for you.

REITs are good for…

Investors who want a hands-off approach to real estate investing and prefer generating passive income in the form of decent dividends.

Real Estate is good for…

Investors who prefer a more managerial approach and have the time and energy to dedicate to managing a physical property and, ultimately, want more direct control over investment decisions.

Investing

The Ultimate Beginner’s Guide To Investing in REITs

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Unlocking the Power of Real Estate Investment Trusts: Your Ultimate Guide to High-Yield Investment Opportunities

REIT

Key Takeaways

  • Determine your investment goals. Before investing in REITs, it’s important to determine your investment goals and risk tolerance. REITs can provide exposure to the real estate sector and income-producing investments, but they are subject to the same risks as other investments and may not be suitable for everyone.

  • Understand the different types of REITs. There are several REITs, including equity REITs, mortgage REITs, hybrid REITs, and public REITs. Understand the differences between these REIT types and how they generate revenue to make informed investment decisions.

  • Research REITs. Perform due diligence and research the REITs you’re considering. Look at factors such as the REIT’s management team, financial performance, and investment strategy to ensure it aligns with your investment goals.

  • Consider your allocation: Decide how much of your portfolio you want to allocate to REITs. As with any investment, it’s important to diversify your portfolio and not put all your eggs in one basket.

  • REITs offer diversification: REITs offer the opportunity to invest in a diverse portfolio of real estate assets, such as office buildings, shopping centers, apartments, and warehouses. This diversification can help to reduce the risk of investing in a single property.
  • REITs offer income: Many REITs pay dividends to their shareholders, which can provide a steady stream of income. The dividends paid by REITs are often higher than those paid by other types of stocks, which makes them attractive to income-focused investors.
  • REITs are required to pay out a certain percentage of their income as dividends: REITs are required by law to pay out at least 90% of their taxable income as dividends to shareholders. This requirement helps to ensure that REITs generate a consistent stream of income for investors.

What Are REITs?

A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating commercial real estate. REITs can own or invest in properties like office buildings, apartments, hotels, shopping centers, and warehouses, to name a few.

REITs can be publicly traded or non-traded. Publicly traded REITs are easily bought and sold on a stock exchange like the NASDAQ or NYSE. Non-traded REITs are operated outside the public market and are subject to less regulatory oversight.

Either way, for a company to qualify as a REIT, they are required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends, making them an attractive investment for income-seeking investors.

The real estate investment trust (REIT) market is a significant component of the overall stock market but is smaller than the broader stock market. REITs account for about 2% of the total stock market capitalization, according to the National Association of Real Estate Investment Trusts (NAREIT).

Short History of REITs

The concept of real estate investment trusts (REITs) dates back to the early 20th century.

In the 1930s, Congress created a tax provision to encourage the development of REITs to provide individuals with an opportunity to invest in large-scale, income-producing real estate.

The first REIT was formed in 1960 by a group of investors led by Ralph Block, a real estate developer. The REIT, called Equity Life Financial Corporation, was created to acquire and manage a portfolio of properties in the western United States.

In the following decades, REITs grew in popularity as a way for individuals to invest in real estate without the high upfront costs and management responsibilities associated with owning individual properties.

In the 1990s, REITs began to be traded on public stock exchanges, which made them more accessible to individual investors.

Today, there are hundreds of REITs listed on public exchanges, and they are a widely accepted and respected part of the investment landscape.

Investment Plan

Types of REITs

There are three main types of REITs that investors can choose from; Equity, Mortgage, or Hybrid. REITs can also be publicly traded or non-traded and usually pay either monthly or quarterly dividends to investors.

Equity REITs

Equity REITs are the most common type of REIT that most people think about when they hear the term ‘REIT’. These REITs own and operate income-generating properties and generate revenue through rent payments.

They typically own and operate a portfolio of income-generating real estate assets like office buildings, apartments, shopping centers, and self storage.

The value of an equity REIT’s assets is derived from the income and capital appreciation of the properties it owns.

Equity REITs may be focused on a particular type of property or sector, such as retail, healthcare, or industrial properties. They may also have a diversified portfolio of properties in multiple sectors.

Mortgage REITs

These REITs invest in mortgage-backed securities (MBS) and other mortgage-related assets.

These assets generate income for the REIT through the interest and principal payments made by borrowers on the mortgages in the underlying MBS. Mortgage REITs can be publicly traded on exchanges or privately held, and they may focus on a specific type of mortgage asset, such as residential or commercial mortgages.

Some mortgage REITs also originate and underwrite mortgages as part of their investment activities.

Hybrid REITs

As the name suggests, hybrid REITs combine elements of equity REITs and mortgage REITs.

This type of REIT invests in a mix of real estate assets, like office buildings, shopping centers, and apartments. Hybrid REITs may also invest in mortgage-backed securities (MBS) and other mortgage-related assets, as well as other types of securities and financial instruments.

The investment strategy of a hybrid REIT is designed to provide diversification and the potential for higher returns through a combination of income-generating assets and assets that may appreciate in value over time.

Hybrid REITs may be publicly traded on exchanges or privately held.

Public REITs

These REITs are traded on public stock exchanges and are easily bought and sold by accredited and non-accredited investors through the stock market. Public REITs are subject to additional regulatory oversight and reporting compared to private REITs.

Private REITs

Private or non-traded REITs are not traded on public stock exchanges. Instead, they are privately owned and may be owned by a small group of investors or a single individual.

Private REITs often have more flexibility in their investment strategies because they are not subject to the same regulatory requirements as publicly-traded REITs.

Because these REITs have fewer regulatory requirements, they may offer investment opportunities not available through publicly-traded REITs.

However, private REITs may be more illiquid than publicly-traded REITs, making it harder to sell your investment if needed. Private REITs may also be more difficult for investors to access as they are not widely available to the general public.

Private REITs can be a good investment option for individuals who are looking for the opportunity to invest in real estate without the need to directly buy and manage property.

How to Analyze REITs

There are several key factors to consider when analyzing REITs. The foundational characteristics beginner investors should consider are the business fundamentals, the management team, financial performance, debt levels, and overall market conditions.

Fundamentals

Investors should analyze the underlying fundamentals of a REIT, including its portfolio of real estate assets, occupancy rates, and tenant mix.

They should also consider the quality and location of the properties in the REIT’s portfolio, as well as the terms of its leases.

Management Team

The management team of a REIT plays a crucial role in the success of the company. Look for REITs with experienced management teams that have a track record of success in the real estate industry.

Financial Performance

As with any investment, it’s important to review the REIT’s financial performance. Look at metrics such as revenue, earnings, and dividends to get an idea of the REIT’s financial health.

You should also check out the REIT’s balance sheet to determine its financial strength and ability to pay dividends.

Debt Levels

REITs often have significant levels of debt. They often use leverage to finance their operations. It’s important to consider the REIT’s debt levels and how they are managing their debt in relation to its assets.

Market Conditions

The real estate market can be volatile, and REITs are subject to the same market conditions as other real estate investments. Market conditions can have a significant impact on REITs and can affect the value of a REIT.

When the overall market is doing well, and there is strong economic growth, REITs may benefit from increased demand for real estate properties and higher rental rates. In these conditions, REITs may see an increase in the value of their properties, as well as increased revenues from higher occupancy rates and rental income. This can lead to higher dividends for shareholders and an overall increase in the value of the REIT’s stock.

On the other hand, when the market is experiencing a downturn or there is economic uncertainty, demand for real estate properties may decrease, and rental rates may decline.

This can lead to lower revenues for REITs and a decrease in the value of their properties. In these conditions, REITs may see a decrease in the value of their stock and lower dividends for shareholders.

In addition to these factors, it’s also a good idea to consider the REIT’s overall investment strategy and whether it aligns with your investment goals.

Incorporating REITs in your Portfolio

In terms of how REITs fit into an overall investment portfolio, it’s generally recommended to include a mix of different asset classes in a portfolio to achieve diversification.

Chess Board with Real Estate
REITs are the 3rd largest asset class, representing 15% of the U.S. market.

REITs can be a good investment option for investors looking to invest in real estate without the need to buy property and own income-producing assets.

If you are considering incorporating REITs into your investment portfolio, here are some steps you can follow:

1. Determine your investment goals

The first step in incorporating REITs into your investment portfolio is to determine your investment goals.

Are you looking for income, capital appreciation, or a combination?

Understanding your investment goals will help you to determine the right mix of REITs to include in your portfolio and is the key to building wealth through real estate.

Many investors who are younger than 50 should primarily still be looking for capital appreciation, while older investors who built their nest egg already generally look to generate income from their assets.

2. Consider your risk tolerance

It’s important to consider your risk tolerance when incorporating REITs into your investment portfolio.

REITs may be subject to market volatility and can fluctuate in value based on economic and market conditions.

There are several factors that can impact your risk tolerance.

Investment goals

As mentioned above, your investment goals, such as whether you are saving for retirement or a short-term goal, can impact your risk tolerance. For example, if you are saving for a long-term goal, you may be more willing to accept higher levels of risk in your investment portfolio.

Time horizon

The length of time you have to invest can also impact your risk tolerance. If you have a longer time horizon, you may be able to afford to take on more risk, as you have more time to recover from any short-term losses.

Personal financial situation

Your personal financial situation, including your net worth, income, and other financial commitments, can influence your risk tolerance. If you have a large net worth or a stable income, you may be able to afford to take on more risk in your investment portfolio.

Personality

Your personal characteristics, such as risk aversion and willingness to take on risk, can also impact your risk tolerance. Some individuals may be more comfortable taking on higher levels of risk, while others may prefer more conservative investments.

Make sure you are comfortable with the potential risks of investing in REITs before adding them to your portfolio.

3. Diversify your REIT holdings

It’s important to diversify your REIT holdings to reduce the risk of investing in a single REIT or sector of the real estate market.

You can diversify your REIT holdings by investing in a mix of REITs that own different real estate assets, such as office buildings, shopping centers, apartments, and warehouses. Diversifying your REIT holdings can be easy by investing in a REIT ETF or REIT mutual fund.

4. Monitor your holdings

It’s important to regularly monitor your REIT holdings to make sure they are still aligned with your investment goals and risk tolerance.

You should review the financial health and performance of your REIT holdings and make any necessary adjustments to your portfolio as needed.

Incorporating REITs into your investment portfolio can be a good way to gain exposure to the real estate market.

It’s important to carefully consider your investment goals, risk tolerance, and the characteristics of the REITs you are considering before making a decision to invest.

PROs and CONs

Like any investment, there are several pros and cons to investing in REITs.

Pros

  • Inflation hedge. In 17 of the last 20 years, REIT dividend increases outpaced inflation when compared to the Consumer Price Index (CPI), according to REIT.com
  • Diversification. REITs can provide exposure to a diverse range of real estate assets, such as office buildings, shopping malls, and apartments, which can help to spread risk and potentially reduce volatility in an investment portfolio.
  • Income. REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends, which can provide a regular stream of income to investors.
  • Potential for capital appreciation. As the value of the underlying real estate assets increases, the value of the REIT may also increase, providing investors with the potential for capital appreciation.

Cons

  • Lack of control. As an investor in a REIT, you have limited control over the specific properties in the portfolio and how they are managed.
  • Interest rate sensitivity. REITs may be more sensitive to changes in interest rates, as higher interest rates can make it more expensive for REITs to borrow money and may reduce the value of existing fixed-income investments held by the REIT.
  • Dividend risk. REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends, but there is no guarantee that dividends will be paid or that they will be sustained at current levels.

How To Buy REITs

Buying REITs is easy. There are several ways to buy real estate investment trusts (REITs):

Through A Brokerage Account

Many REITs are traded on public stock exchanges, so you can purchase them through a brokerage account like any other publicly traded stock. You can open a brokerage account with an online broker like M1 Finance or through a financial advisor.

Through REIT Mutual Fund or ETF

If you don’t want to buy individual REITs, you can invest can a REIT mutual fund or REIT ETF, which allows you to own a diversified portfolio of REITs. These funds can be purchased through a brokerage account or directly from the fund company.

Through Real Estate Crowdfunding

Some companies offer their own investment trusts, which allow investors to purchase shares in the REIT directly. This form of investing is usually done through real estate crowdfunding.

This can be a good option for investors who want to own a specific REIT and are comfortable with a longer-term investment horizon.

How Are REITs Taxed?

Real estate investment trusts (REITs) are taxed differently than other corporations and is one of the main reasons investors are attracted to REITs.

REITs are required to pay at least 90% of their taxable income as dividends to shareholders, and these dividends are generally taxed as ordinary income at the shareholder level.

REIT dividend taxes have two significant differences compared to most stock dividends

  1. Dividends are usually taxed at the ordinary income rate instead of the long-term capital gains tax rate
  2. A portion of the dividend may be classified as Return of Capital, which reduces an investor’s cost basis if the shares are sold.

Plus, REITs are also eligible for a special tax treatment known as the “pass-through” tax treatment.

Under this treatment, REITs are not taxed at the corporate level on their income. Instead, the income is passed through to the shareholders and taxed at the individual shareholder level. This can potentially result in a lower overall tax rate for REITs compared to other types of corporations.

It’s important for investors to be aware of the tax implications of investing in REITs and to consult with a financial advisor or tax professional for guidance on how REITs may be taxed in their particular situation.

Who Should Invest In REITs?

Real estate investment trusts can be a good investment option for various investors, depending on their investment goals and risk tolerance.

REITs are good for…

  • Investors who want to add diversification to their portfolio through real estate
  • Earn capital appreciation
  • Generate income through dividends
  • Individuals who want to invest in real estate but do not want to buy physical property due to a lack of industry expertise

REITs are NOT good for…

  • Investors who are looking for short-term investments
  • Risk-averse investors. REITs carry their own set of risks, including interest rate risk, property market risk, tenant risk, management risk, and liquidity risk.
  • Investors who are not comfortable with the tax implications of REITs. Because they are required to pay out at least 90% of their taxable income as dividends to shareholders, REIT investors may be subject to higher tax rates on their dividend income. If you are not comfortable with this tax implication, REITs may not be the best choice for you.

Historic Performance

Historically, REITs have provided investors with the potential for strong returns and a stable source of income.

According to the National Association of Real Estate Investment Trusts (NAREIT), the average annual total return for REITs from 1972 to 2020 was 12.3%, compared to 9.8% for the S&P 500 over the same time period.

The performance of real estate investment trusts (REITs) can vary over time and is influenced by various factors, including economic conditions, interest rates, general real estate market trends, and the industry in which the REIT operates. Overall, REITs tend to perform well in a strong economy and when interest rates are low.

However, REITs may also be influenced by factors specific to the real estate market, such as changes in interest rates, occupancy rates, and property values.

Fees Explained

All REITs typically charge fees to cover the costs of managing and maintaining the properties in their portfolio. These fees can include management fees, acquisition/disposition fees, and financing fees.

  • Management Fees. Charged by the REIT to cover the costs of managing the properties in its portfolio, such as property management, maintenance, and repairs.
  • Acquisition and disposition fees. These are charges that the REIT incurs when it buys or sells properties. These fees can include legal fees, appraisal fees, and brokerage fees.
  • Financing fees. These are charges the REIT incurs when it borrows money to fund acquisitions or other business activities. These fees can include interest on loans and fees charged by lenders.

Overall, the fees associated with REITs can vary depending on the REIT and the services it provides. It is important for investors to carefully consider the fees associated with a REIT before investing.

REIT ETFs

REIT ETFs have an average expense ratio of 0.41%, according to ETF.com, making REIT ETF fees lower than REIT mutual funds and individual REITs.

The average fee for a real estate investment trust (REIT) exchange-traded fund (ETF) can vary depending on a number of factors, including the specific fund, the services it provides, and the assets it invests in.

REIT Mutual Funds

The average expense ratio for REIT mutual funds is 0.79%, according to Morningstar, a financial research firm.

It’s important to note that this is the average expense ratio for REIT mutual funds. The actual fee for a specific REIT mutual fund may be higher or lower depending on the fund and the services it provides.

In addition to the expense ratio, REIT mutual funds may also charge other fees, such as 12b-1 fees (marketing and distribution fees) and redemption fees (fees charged when you sell your shares in the fund).

REIT mutual funds tend to have higher fees compared to REIT ETFs. This is because mutual funds are actively managed, whereas ETFs are generally passively managed, thus making REIT ETFs generally cheaper.

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