How To Invest In REITS
Real estate investment trusts (REITs) are an important consideration when building any equity or fixed-income portfolio. These trusts offer greater diversification, potential higher total returns, and/or lower overall risks. In addition, their ability to generate dividend income and capital appreciation makes these an excellent counterbalance for stocks, bonds, cash, and cash.
Investment trusts manage and own income-producing real estate. This includes the properties or mortgages. The companies can be purchased individually, with an exchange-traded fund or as a mutual fund. There are many types available in REITs.
We will be looking at some of the most popular REITs categories and their historical returns. You should now have a better understanding of when and how to buy.
Historical Returns Of REITs
The best performing asset class is historically real estate investment trusts. Most investors use the FTSE NAREIT EIT Index to measure the performance of the U.S. housing market. The index's average annual return between 2010 and 2020 was 9.5%.
Retail REITs
This is the largest type of investment in America. A REIT is likely to own any shopping center that you visit. Before you consider investing in retail real property, it is important to evaluate the industry. What is its financial health right now, and what are the prospects for the future?
Retail REITs make their money by charging tenants rent. Retailers who are having cash flow issues due to poor sales could be forced to file bankruptcy. It is necessary to find a new tenant at that time, which can be difficult. Therefore, it is crucial to invest in REITs that have strong anchor tenants. These anchor tenants include grocery and home-improvement stores.
After you have completed your industry assessment, your attention should shift to REITs. REITs need to have strong balance sheets, good profits, and low levels of debt. Retail REITs with substantial cash positions can purchase distressed real estate in a weak economy. This will be a benefit to the best-run businesses.
However, the longer-term risks for retail REITs space are that shoppers are increasingly shopping online. In addition, the sub-sector is facing pressure as space owners continue to invent to fill their spaces with offices and other non-retail tenants.
Residential REITs
These REITs own and manage multi-family rental apartments as well as manufactured homes. Before you invest in this type of REIT, there are several things to consider. The best apartment markets are those where the cost of housing is lower than the rest of the country. Los Angeles and New York are two examples of cities where renters can be forced to pay higher rents due to the high cost of single-family homes. The largest residential REITs are concentrated in large urban centers.
Investors should focus on the growth of employment and population within each market. If there is a net flow of people into a market, it is usually because jobs are plentiful and the economy is expanding. Increasing rent and a falling vacancy is an indicator that demand is rising. Residential REITs will do well as long as there is a low supply of apartments in that market and rising demand. Like all businesses, the ones with strong balance sheets and access to capital are the best.
Healthcare REITs
As Americans get older and healthcare costs rise, Healthcare REITs will be a fascinating sub-sector to keep an eye on. Healthcare REITs invest in the real estate of hospitals and nursing homes and medical centers. Healthcare REITs are directly linked to the success of this real estate. The majority of operators of these facilities depend on occupancy fees, Medicare reimbursements, and Medicaid private pay. Healthcare REITs are also subject to uncertainty as long as funding healthcare remains a problem.
You should be looking for a REIT that offers healthcare investment options. This includes diversification of customers and investments in different types of property. While the focus is important to a certain extent, spreading your risk is better. Healthcare real estate is generally good for those who are looking to invest in healthcare. To diversify your customer and property portfolios, you should also look for companies with significant healthcare experience, strong balance sheets, and easy access to capital.
Office REITs
Office REITs invest money in office buildings. Tenants who have signed long-term leases are eligible to receive a rental income. For anyone interested in buying an office REIT, four questions are immediately triggered.
How is the economy doing?
What is the vacancy rate?
What economic performance is the REIT investing in?
What amount of capital does it have to acquire assets?
Mortgage REITs
Approximately 10% of REIT investments in mortgages are in real estate.
This type of REIT does not invest in equity but in mortgages. A rise in interest rates could lead to a decline in the book value of mortgage REITs, which would drive stock prices down. Mortgage REITs also receive a significant amount of their capital via secured and unsecured debt offerings. Future financing will become more costly if interest rates rise. This can reduce the portfolio's value. Most mortgage REITs trade at a discount to their net asset value per share in a low-interest-rate environment. Finding the right one is the trick.
How To Assess Any REIT
When assessing any REIT, there are some things you should keep in mind. These are the most important:
REITs are true total return investments. These REITs offer high dividend yields and moderate long-term capital appreciation. Companies that can provide both should be considered.
Many REITs can be traded on stock exchanges, which is a departure from traditional real estate. Diversification is possible without having to be locked in long-term. Liquidity is important.
The tendency of depreciation to exaggerate a property's loss is called overestimation. Instead of using the payout rate (which dividend investors use) for assessing a REIT's value, consider its funds out of operations (FFOs). This is the net income less any property that was sold in a particular year and depreciation. Divide the dividend per share by the FFO per share. The better the yield, the better.
A strong management team is a key to success. You should look for companies that have been around a while or at the very least have a strong management team.
It is important to be high quality. Only invest in REITs that have great tenants and properties.
You can buy a mutual fund, ETF, or ETF that invests only in REITs and lets professionals do the research and purchase.
Advantages And Disadvantages Of REITs
Like all investments, REITs come with their advantages and disadvantages. High-yield dividends are one of the greatest benefits REITs offer. REITs must pay 90% of their taxable income to shareholders. As a result, REIT dividends can often be much higher than the average stock in the S&P 500.
Portfolio diversification is another benefit. Many people don't have the means to buy commercial real estate to generate passive income. However, REITs allow the public to do this. Although buying and selling real property can take a long time, it can also tie up cash flow. However, REITs are extremely liquid; most can be purchased or sold in a matter of seconds.
Investors should be aware of the potential tax liability that REITs could create. The IRS does not consider REIT dividends qualified dividends. This means that the higher-than-average dividends REITs offer are subject to a higher tax rate than other dividends. While REITs are eligible for the 20% pass-through deduction, most investors will have to pay large amounts of taxes on REIT dividends if they hold them in a standard brokerage account.
Another problem with REITs could be their high sensitivity to interest rate changes. Reit prices tend to fall when the Federal Reserve raises its interest rates to increase spending. Different types of REITs are also subject to property-specific risks. During times of economic decline, hotel REITs are often very poor.
Pros
High-yield dividends
Portfolio diversification
Highly liquid
Cons
Dividends are subject to the same tax as regular income.
Sensitivity to interest rate fluctuations
Certain properties carry risks
FAQs About REIT
Are REITs good investments?
REITs are a great way of diversifying your portfolio beyond traditional bonds and stocks. They can also be attractive because they pay strong dividends and offer long-term capital appreciation.
Which REITs should I invest in?
Each REIT type has its own risks and benefits, depending on the economic state. A REIT RETF allows shareholders to invest in this sector without having to deal with the complexities.
How do you make money with a REIT?
The IRS requires REITs to pay 90% of their taxable income back to shareholders. As a result, REIT dividends can be much higher than average stocks on the S&P 500. The compounding of high-yield dividends is one of the best ways of passively earning income from REITs.
Is it possible to lose money on a REIT?
There is always the risk of losing your investment. As interest rates rise, publically traded REITs are at greater risk of losing their value. This is because investment capital goes into bonds instead.
Are REITs safe during a recession?
In times of economic downturn, it is not good to invest in certain REITs such as those that own hotel properties. However, it is possible to hedge against recessions by investing in other types, such as retail or health care, that have longer lease terms and are less cyclical.
The Summary
Investors can now buy large-scale commercial real property projects by the federal government since 1960. However, individual investors have only started to embrace REITs in the past decade.
Low-interest rates forced investors to look beyond bond investments for income-producing investment options. The advent of mutual funds and exchange-traded funds that focus on real estate was also a factor. Until the 2007-08 realty meltdown, Americans had an insatiable desire to own real property and other tangible assets. Like every other investment, REITs suffered greatly in 2008. However, they are still a great addition to any portfolio.
