The Ultimate Beginner’s Guide To Investing in REITs

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January 2, 2023
10 Minute Read

In this guide to REIT investing, we will tell you everything you need to know to get started.

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
Multiple studies show that the optimal REIT portfolio is between 5% – 15%, according to REIT.com

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 warehouses.

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, meaning it may be harder to sell your investment if you need to. 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.

However, 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.

Frequently Asked Questions

Real World Investor

Adam

Adam is the founder of realworldinvestor.com, an investing website dedicated to helping discerning individuals make the best investment decisions.

Before starting Real World Investor, he was a Senior Vice President at one of the country's largest investment banks. He has over 10 years of experience working in financial services. His experience includes working with complex derivatives while spending many years working on a trading floor.

He has a bachelor's degree in Business Administration, majoring in finance.