Real estate investment trusts, or REITs, are a popular investment vehicle that allows individuals to invest in real estate without having to buy and manage property themselves. But what exactly are REITs, and how do they work?
A REIT is a company that owns and operates income-generating real estate properties, such as apartment buildings, office buildings, shopping centres, and hotels. REITs are designed to provide regular income to investors in the form of dividends, while also offering the potential for capital appreciation through the appreciation of the underlying real estate assets.
One of the key advantages of REITs is their tax efficiency. Under US law, REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends, which are taxed at the individual’s income tax rate. This means that REITs can avoid paying corporate income tax, making them more efficient at generating income for investors.
REITs have been around for over 60 years, but they really took off in the 1990s when changes were made to the tax code that made them more attractive to investors. Since then, REITs have become a popular way for individuals to invest in real estate, with over $1.5 trillion in total assets under management as of 2021.
There are two main types of REITs: equity REITs and mortgage REITs. Equity REITs invest in and operate income-generating real estate properties, while mortgage REITs invest in and own mortgage-backed securities, which are pools of mortgages that have been securitised and sold to investors.
Equity REITs are the more common of the two, and they are what most people think of when they hear the term “REIT.” These companies own and operate real estate properties, and they generate income through rent payments and property appreciation. Equity REITs are further categorised into different property types, such as office, residential, retail, and industrial.
Mortgage REITs, on the other hand, invest in mortgage-backed securities and generate income through the interest payments on those securities. Mortgage REITs are generally considered to be riskier than equity REITs because they are more susceptible to interest rate fluctuations and changes in the housing market.
When investing in REITs, it’s important to keep in mind that they are subject to the same market forces as any other investment. Real estate values can fluctuate based on a variety of factors, such as interest rates, economic growth, and supply and demand. As such, investors should do their due diligence and carefully evaluate the underlying real estate assets before investing in a REIT.
Despite the risks, REITs have historically been a strong performing asset class. According to data from the National Association of Real Estate Investment Trusts (NAREIT), the FTSE NAREIT All Equity REITs Index has produced an average annual return of 9.9% over the past 20 years, outperforming the S&P 500 Index, which has produced an average annual return of 7.4% over the same period.
There are a few other things to keep in mind when investing in REITs. For example, some REITs are publicly traded on stock exchanges, while others are private. Publicly traded REITs offer the benefit of liquidity, meaning that investors can buy and sell shares on a daily basis. Private REITs, on the other hand, may offer higher potential returns but are generally less liquid.
Another consideration is the fees associated with investing in REITs. Like any other investment, REITs come with management fees and other expenses, which can eat into your returns. Investors should carefully evaluate these fees before investing in a REIT.
REITs can be a great way for individuals to invest in real estate without having to buy and manage property themselves. They offer tax efficiency, regular income in the form of dividends, and the potential for capital appreciation. However, as with any investment, it’s important to do your due diligence and carefully evaluate the underlying real estate assets, fees, and risks before investing in a REIT.