What Are REITs and its Types, Benefits, and how can we enter into this market

Ever thought about investing in real estate but don’t want the hassle of owning physical properties? That’s where REITs come in! REITs, or Real Estate Investment Trusts, are companies that own or finance income-producing real estate. Think of them as a way to invest in a portfolio of properties without actually buying and managing them yourself.

REITs come in different types, each focusing on a specific kind of real estate. There are equity REITs, which own properties like apartments, offices, and shopping centers, and mortgage REITs, which finance real estate by owning mortgages or mortgage-backed securities. Each type has its own set of benefits and risks. Investing in REITs can offer several advantages, such as regular income through dividends, diversification in your portfolio, and the potential for long-term growth. Plus, it’s generally easier to get into the REIT market compared to directly buying real estate.

What Are REITs?

A REIT, which is short for Real Estate Investment Trust, is a company that owns and manages real estate that earns a profit. For example, you might want to invest in a large shopping mall or a large apartment building, but do not have the millions of dollars required to buy a mall or a large apartment building. A REIT allows investors like yourself to pool your money with other investors to purchase a whole portfolio of real estate properties such as office buildings, apartments, hospitals, and warehouses (collectively, commercial real estate). If you buy a share in a REIT, it is as if you have ownership in several properties and buildings that are included in the REIT’s list of properties, without having any ownership of a specific property, and without the responsibility of managing any property. The best aspect of investing in a REIT is that the law dictates that the REIT must pay out at least 90% of its taxable income to its shareholders as dividends. This is one of the reasons that REITs are popular with individual investors, to receive a regular income from real estate, similar to stocks but with the stability and earning capabilities from the real estate investments.

Types of REITs

Mortgage REITs (mREITs):

While most REITs specialize in owning physical types of property, apartments, or shopping malls, for example, Mortgage REITs (or mREITs) operate differently. They are not investors in real estate buildings, but simply lend money to real estate owners or, buy existing mortgages and mortgage-backed securities. In this firm, you can think of them as banks or specialty lenders. Their principal business is financing real estate properties. Thus, the entity makes their money on the difference in interest borrowed at low short-term rates and then lending it out at higher long-term rates on mortgages. This model permits them to pay higher dividends to their investors, however mREIT’s are potentially riskier and are much more responsive to interest rate changes than traditional REITs that own physical property.

Public Non-Traded REITs:

A Public Non-Traded REIT (Real Estate Investment Trust) is essentially a real estate company that investments in properties but is not listed on the NYSE or Nasdaq, similar to a hybrid vehicle since it’s “Public” because it is registered with the SEC and available to the general public often thought through financial advisors and “Non-Traded” because its shares will not be bought and sold each day on a public stock market. Therefore, their share price will not fluctuate or move with other daily market news, which could help lessen volatility. However, the major trade-off is less liquidity you will have, the cash value of your investment cannot quickly be unlocked so if you needed a cash amount co-insiding your shares, you cannot obtain it. They are usually made durationally long for your investment money to be in the vehicle, locking you up with your money for 5 to 10 years before you are allowed to sell usually by meeting periodically through a share-repurchase program or listing as a public exchange. Although they can provide income, often the trader does not get back by paying excessive upfront fees, in addition to being made a simple vehicle over complex as well as risk you can obtain through liquidity.

Publicly Traded REITs:

Publicly traded REITs represent the most commonly traded and easily accessible type of REIT for everyday investors. By investing in a public REIT, the investor is buying shares in a company that owns income-producing real estate, similar to the owner of shares of Apple or Coca-Cola. Publicly traded REIT shares are bought on major stock exchanges like the New York Stock Exchange (NYSE) or Nasdaq and can be sold at the click of a button during market hours, creating the most liquidity and flexibility of any investment option made by individuals. Since the share price of a publicly traded REIT fluctuates throughout the trading day, the share price can change substantially based on the stock market, which makes these REITs a more volatile investment, but more specifically, an investment that can accommodate a higher level of transparency relative to non-traded REITs. Publicly traded REITs are often recognized for consistently paying attractive dividends, and they provide a convenient way to gain exposure to real estate in an investment portfolio without the burden of being a landlord.

Equity REITs:

Equity REITs are the most prevalent type of REIT that work as most people would envision a REIT to work. The companies that comprise an Equity REIT do not lend money; they directly own and manage a portfolio of income-generating properties such as apartment buildings, shopping malls, office buildings, and warehouses. As an Equity REIT shareholder, you own a fractional share of this entire portfolio of properties. The Equity REIT generates income primarily through rent charged to tenants occupying their properties, and they must distribute most of that rental income to investors as regular dividend payments. This is why Equity REITs are regarded as a useful source of income while also providing benefits if the underlying real estate appreciates in value over time.

Specialty REITs:

Specialty REITs are a distinct class focusing on the ownership and operation of very specific, sometimes unusual, types of properties that likely don’t fit into traditional categories like offices and malls. You can think of them as the niche specialists of the real estate industry. Specialty REITs typically invest in properties providing essential services that are vital to modern life and modern business. Examples of properties typically housed in Specialty REITs include cell phone towers, data centers powering the internet, timberland, movie theaters, casinos, and farming. Investing in a Specialty REIT means you are purchasing an income stream based on those niche assets, often with 15-year+ contracts with their tenants, thus providing you consistent dividend income. This means you can invest in very specific parts of the economy through the consistent structure of a real estate trust.

Hybrid REITs:

A Hybrid REIT combines the two principal REIT strategies to provide the best of both worlds for one customer investment. A Hybrid REIT is essentially a diversified real estate company that owns and operates not only physical properties, but also holds mortgage loans. Therefore, some of the REIT’s revenue comes from the reliable rental income that it earns from its buildings, like an Equity REIT, and part comes from the interest earned from lending money to other property owners, like a Mortgage REIT. This hybrid strategy is intended to provide some balance of income and growth, because the REIT can take advantage of both increased property values (growth) and interest payments (income). For an investor, this can be an effective way to provide diversified exposure to the real estate market without having to make the decision to own physical properties, or to finance them.

Private REITs:

Private REITs are earmarked as real estate investment funds that are not registered with the SEC and do not trade on a listing exchange. Being private REITs means they are the exclusive, less regulated cousins of public REITs. Because they are private, you cannot buy a private REIT with a regular brokerage account like you would buy a public REIT. Private REITs are generally available to large institutional investors, such as pension funds or accredited investors who typically meet certain high income or wealth standards. The upside to investing in a private REIT is that the daily price of the shares is not impacted by the stock market averages. The downside to investing in a private REIT is that because they are private, they are very illiquid. It will not be easy to sell your shares and get your money out of the investment because there is no public market, and they are often sold as long-term, locked-up investments. Private REITs are also less transparent, which makes it difficult to know the real value of your holding or the details of the underlying assets.

Benefits of REITs

• High Dividends: REITs are required by law to distribute at least 90% of their taxable income to potential shareholders. Thus, they can be a very effective mechanism for producing predictable, passive income.
• Affordability and Accessibility: They allow you to share in the ownership of some of the largest commercial real estate properties (malls, skyscrapers, data centers, etc.) without needing nearly as much cash as it takes to acquire outright properties.
• Diversification: Real estate usually has different performance cycles and parameters than most stocks and bonds. While they can be viewed differently or separately, REITs can facilitate your residential portfolio’s return and risk profile, thereby improving diversification of risk and reducing volatility.
• Liquidity (Publicly-Traded REITs): Unlike a physical property, where you can wait months to sell, shares of publicly traded REITs can be purchased and sold very quickly on a major stock exchange.
• Professional Management: The REIT company takes care of all the daily headaches of owning a real estate property (finding tenants, repairs, collecting rents) so you don’t have to do any of that and receive the benefits.
• Transparency (Publicly-Traded REITs): As a registered public company, they have to produce a managed financial statement indicating how they are doing financially and how many properties they own, so the investor knows what is transpiring.

Risks of REITs

• Interest Rate Sensitivity: REITs are often more sensitive to rising interest rates. Increasing rates can lead to higher borrowing costs for their new investments, which results in reduced profits. Their substantial dividends are also less appealing than other income options, like bonds, which leads to decreasing share prices.
• Market Risk (Publicly Traded REITs): Publicly traded REITs experience daily share price fluctuations according to market prices, economic news events, and investor sentiment. This means the value of your investment can decline irrespective of performance of actual real estate.
• Property Market Decline: REITs are directly tied to the state of the property market. During a recession, property values drop, or when vacancy rates rise this can lead to declines in rental income for the REIT, which can reduce dividends and subsequently the value of the stock.
• Liquidity Risk (Non-Traded & Private REITs): Non-traded and private REITs are very illiquid. You may be locked-in for many years (usually 5-10) without an exit strategy, and early redemption can be cumbersome, or costly, or both.
• Extensive Leverage: Many real estate investment trusts (REITs) invest heavily in properties using a considerable amount of debt (leverage). If the values of their properties decline or rental income drops, they may find it more difficult to service their debt obligations, making it riskier for the REIT to continue operating.
• Sector-Specific Risks: A REIT that specializes in a single sector has risks related to that sector. For example, a retail mall REIT has risk associated with the “retail apocalypse” and online shopping and an office REIT has risk if remote work is considered standard and long-term vacancies occur.
• Management Risk: How a REIT performs is largely determined by its management team’s skill level. Bad decisions about what properties to buy, how to manage properties, or how to handle debt can all impact your return.

How to Enter the REIT Market

Investing in the REIT market is a pretty simple affair, ultimately the same process of just buying a stock. The simplest and most common method for an individual investor to get into REITS is by buying shares of a publicly listed REIT in any normal brokerage account, which could be Fidelity, Vanguard, Charles Schwab or similar. After setting up an account and funding it, you can search for your REIT, using the ticker symbol (for instance, “O” for Realty Income) and in a few clicks, purchase shares the same way you would purchase any other company’s stock. If a person preferred a way to diversify their capital more than putting it into one single REIT, they could buy a REIT ETF or mutual fund, which is multiple REITs bundled into one stock, giving good instant diversity to spread the risk across property types and companies. Also, REITs or an ETF doesn’t require a large amount of money to get started; meaning you could start with a small amount and expect to be receiving dividends very quickly from a professional real estate portfolio.

Example Investment Scenario

• Goal: Generate passive income.
• Investment: $5,000 in a REIT ETF (e.g., VNQ, with a dividend yield of ~3.5%).
• Expected Annual Dividend: ~$175 (3.5% of $5,000, assuming no price changes).
• Steps:
  1. Open a brokerage account with Fidelity.
  2. Research VNQ’s holdings and performance.
  3. Buy ~50 shares of VNQ at ~$100/share.
  4. Receive quarterly dividends and reinvest or withdraw as needed.

Conclusion

In conclusion, REITs are a simple way to invest in real estate, income potential, and diversification. If you have an interest in residential, commercial, or a special type of property- there is probably a REIT that aligns with your investment objectives. The barrier to enter the REIT space is low as there are many investment platforms that allow this investment, so it is worthy of consideration by a new or experienced investor. If you understand the types of REITs, the positives, and how to get in, you can make a decision if REIT investing is a part of your strategy.

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