There are many ways to invest in real estate. When most people envision what real estate investing looks like, they usually think of house-flipping or buying a rental property and becoming a landlord. The truth is, there are a variety of other ways you can make money in the real estate realm, and real estate investment trusts (REITs) can be a great place to start.
Buying a home to flip or purchasing an investment property requires a lot of personal financial risk. What if the cost to improve a home you are flipping goes way over budget? What if the rental property fails because you can’t find good tenants? You get the idea. When it comes to investing in real estate without buying property, REITs might be the way to go.
REITs mitigate some of this risk because you aren’t going it alone. Along with other investment partners, you invest in a group that handles the day-to-day management of properties for you. With more investors involved, the risk is spread across more people. Of course, the profits are as well.If you’ve been wondering how to invest in real estate for passive income, REITs are a great option to consider. You don’t need to start with a massive amount of capital, and you don’t need to be an expert in picking suitable investment properties. Read on to find out what REITs are, how to start investing in them, and how to decide if they are right for you.
What Is A Real Estate Investment Trust (REIT)?
Investors familiar with publicly traded stocks and mutual funds know that you can invest in real estate-related stocks just like any other publicly-traded company. Historically, real estate has been a high-yield business, so investing in stocks related to the industry is appealing. Real estate investment trusts take putting your money into real estate a step further but stop short of buying and selling the property yourself.
In a REIT, many investors come together to pool their money and purchase real estate. Once the property is purchased, the REIT creates income for its investors in various ways. Often, they will find tenants and rent the property to generate rental income. In addition, REITs can sell the property for more than they purchased it for and disperse the profit to the trust members.
One of the appealing features of REITs is that they are legally required to disperse 90 percent of the income they create back to their investors. This offers investors some assurances that if the properties acquired by the REIT become worthwhile investments, the members of the REIT are guaranteed to see those returns.
REITs are also required to invest at least 75 percent of their total assets in real estate or cash and receive a minimum of 75 percent of their gross income from real estate. This income includes rent, property sales, and interest on mortgage loans used to finance the property. Other rules that apply to REITs have to do with the number of shares and shareholders they can include. REITs must have no more than 50 percent of their shares held by five or fewer individual people during the last half of the taxable year. In addition, they must have at least 100 shareholders one year after the REIT is established.
These rules allow REITs to enjoy some tax benefits. REITs pay less than the usual corporate tax level, so they can acquire properties more cheaply and pay more profits out to their investors.
Types Of REITs
REITs can be traded publicly, just like other stocks, or they can be private, non-traded REITs. There are also public REITs that are not traded. In addition, you can invest in mortgage REITs, equity REITs, and hybrid REITs.
REITs can also relate to specific types of businesses. These include residential, retail, office, and healthcare. Read on for an in-depth look at all the various types of REITs you may want to consider investing in.
Publicly Traded REITs
Only publicly-traded REITs can be found on a stock exchange. They can be bought and sold just like any other stock. Just like stocks, they can be bought and sold quickly using your usual brokerage account. This makes them appealing to investors that don't have the time and money to purchase commercial properties themselves and wait many months or years for a return.
Like other publicly traded companies, publicly-traded REITs tend to be more transparent than private, non-traded REITs. Some investors prefer publicly traded REIT stocks to private REITs because they like stocks from companies with established governance standards.
Public Non-Traded REITs
These REITs are registered with the U.S. Securities and Exchange Commission (SEC) but are not available on a stock exchange. To purchase them, you will need to use a broker that specializes in offerings that are public but not traded.
Public non-traded REITs take a while to estimate their value. In fact, sometimes, it can be years before you know the estimated value of the REIT. This means public non-traded REITs require a bit of a “leap of faith.”
Another form of non-traded REITs are private REITs. Unlike public REITs, they are not registered with the SEC. This makes some investors cringe, as private REITs are hard to evaluate, given that they have fewer disclosure rules than public REITs.
The cost of investing in a private REIT is also prohibitive for many investors, as many require you to have a net worth of at least $1 million.
Fannie Mae and Freddie Mac, which are government-sponsored companies that buy mortgages using the secondary market, are the most well-known examples of mortgage REITs. These types of REITs invest only in mortgages and not in actual property.
If you are interested in investing in this type of REIT, keeping a keen eye on interest rates is essential. If they go up, the value of the REIT will decrease. In addition, rising interest rates mean financing becomes more expensive, reducing the value of loans. Since these REITs are essentially a bundle of loans, their value would be lower.
These REITs take on the responsibilities you may associate with a landlord. They collect rent, maintain the property, pay for any improvements, and manage the day-to-day operations. Many investors want to own physical property but don't want to spend all day managing it. Equity REITs allow people to invest in real estate without being a landlord.
If you want to invest in mortgage REITs and equity REITs simultaneously, consider a hybrid REIT. They combine property acquisition and management with bundling mortgages to provide returns for their investors.
Equity REITs that own and operate apartments or manufactured housing are often referred to as residential REITs. Real estate investments like these are heavily dependent on property values and rentability.
For example, rental markets are usually better where home values are high. This means fewer people can afford to purchase a home and instead decide to rent. More renters indicate more likelihood of keeping your building full and the rent checks coming in each month.
Population and job growth are two other vital factors to consider. If a city is seeing an increase in both, more and more people are likely looking for places to rent each year. More demand means higher rental rates, higher occupancy rates, and more significant returns for residential REITs. They create a profit for their investment from the rent they charge commercial tenants that occupy the buildings they own. If the businesses they rent to are booming, the money comes in each month.
However, if retailers are thin on cash due to slow business, they may not have the funds to pay the rent. This means the REIT takes a loss as it searches for a new tenant. As you might imagine, finding a new business to take over a commercial lease is a lot more work than finding a new person to rent a single apartment.
Technology trends are significant to consider when investigating retail REITS as well. Have you been to a mall lately? They are not nearly as packed as they used to be, with an increasingly large number of Americans turning to online shopping.
Office REITs invest in - you guessed it - office buildings. Like retail REITs, they make their investors money by charging rent, usually from tenants who have signed long-term leases. Job growth is a critical factor to consider when investigating office REITs. If an area has a growing working population, more people need an office.
Most office REITs target properties in specific cities. It’s a good idea to review the city’s economic strength before investing. Also, look at the vacancy rates. If there are a lot of empty office buildings in the area, the demand for tenants is low.
Technology is again a factor. With more work from home employees, especially during the pandemic, office buildings have spent a lot of time empty or half full. If these trends continue post-Covid, the value of office REITs could decline significantly.
Health care REITs invest in hospitals, nursing facilities, medical centers, and retirement homes. They make money in various ways beyond traditional rent that include Medicare/Medicaid reimbursement and occupancy fees.
The success of health care REITs is directly tied to the larger health care system. If there is a continually increasing need for health care, there will be an increase in the demand for health care real estate. As the population gets older and older, betting on an increase in the need for services is a pretty good bet.
How To Successfully Invest In REITs
REIT investments can be a great part of a diversified portfolio of stocks. Like all stocks, they come with a risk-reward calculation that you’ll need to make. Understanding the best ways to approach REITs is the best way to increase your chances of a healthy financial return.
Understand The Risks
Assessing risk is a critical step before you make any significant investment. This is true when you buy a home, buy a car, invest in traditional stocks, and invest in real estate investment trusts. The usual fluctuation with the rise and fall of the stock market can be expected with REITs, but there are a few more risks unique to these investments to be aware of as well.
REITs are affected by factors that other stocks aren’t. Tenant leases, for example, can provide high income or high cost if they stop paying or move to another location. Fluctuating material and labor costs affect the cost of maintaining and renovating buildings, which affects the value of REITs.
Publicly traded REITs are easier to predict due to more transparency and traditional trust governance. Private REITs are harder to assess, as they often don’t share much information until many months after you are required to invest.
Be In It For The Long Haul
Whether you are interested in investing in publicly-traded REITs, Private REITs, or public non-traded REITs, you should consider them a long-term investment. These aren’t the investment tools you should use if you are looking to get rich quickly.
REITs are dependent on creating income-producing real estate. This is true of both residential and commercial real estate purchases. Sometimes this means waiting for a property to appreciate to sell it at a profit. It can also mean renovating a property to justify increased rent and finding tenants willing to pay the new rates. As you can see, this all takes time.
Publicly traded REITs fluctuate with the stock market, so the longer you hold on to them, the more likely you will be able to weather the dips in the market. With privately traded REITs, you won't be able to access your investment until the shares become public or the REIT liquidates its properties, which can take ten years.
Do Your Research
When you make a residential real estate purchase, like your primary home, the due diligence process is extensive and hands-on. Home inspections, for example, include a review of every nook and cranny of the house. Buying commercial real estate has a similar process.
When you invest in a REIT, you are essentially trusting the REIT management team to do this for you. That means you need to do your homework to ensure they are a company you believe will have your best interest in mind.
Start by investigating the track record of the REIT. Have they consistently provided good returns for their investors? Or have they mismanaged properties, resulting in financial losses? Also, find out how the REIT management team is compensated. Some have fixed fees, and others receive a percentage of the returns they provide to their investors. The latter compensation model is preferable, as they only do well if you do well, so they have some “skin in the game,” so to speak.
Think About Your Financial Goals
With any financial investment, looking at how it fits into your larger financial goals is essential. Will you need access to your cash in the near future? Are you comfortable investing in a REIT with your retirement savings account? How will the timeline of the REITs profitability affect your short and long-term financial future?
These are the types of questions to ask yourself to see if a REIT is a good investment strategy for you. Make sure you only invest what you can afford and if your money being tied up for years is worth the promise of a healthy financial return.
How To Get Started
Getting started with REIT investing starts with opening a broker account - this only takes a few minutes online. Once you do that, you will be able to start investing in publicly-traded REITs just like you would any other stock. You can also invest in a mutual fund that researches and invests in multiple REIT stocks.
For privately traded REITs, you will need a specialized broker. They can research, assess, and present options to you for consideration.
REITs can be a great investment strategy if you want to get income-producing real estate without buying properties by yourself. A REIT with a good management team with a track record of success can find, purchase, rent and sell properties for you and provide an excellent financial return.
Real estate is a complicated business. Real estate companies buy and sell properties at a high rate and make money from them in several ways, but this can be daunting for an individual investor. Consider REITs as a great way to invest in the real estate market by relying on professionals to make the decisions about individual properties for you.