When investors first learn about the option of investing in syndications through online crowdfunding websites, they frequently wonder how they differ from Real Estate Investment Trusts or REITs.
An equity mutual fund is a good analogy for a REIT.
An equity mutual fund can pay a manager of the fund money to make investment decisions and choose a portfolio of stocks for you. It saves you the trouble of comparing and selecting individual stocks.
Similar to REITs, they are a group of real estate properties that are managed and controlled by a committed, experienced management team and in which you can make a direct investment.
Instead of having to pick one specific property to invest in, investors can diversify their capital across many different properties by choosing a REIT. By paying the management team a fee for their services, investors can generate passive income from real estate without taking on direct management responsibilities.
The structure of REITs typically allows them to focus on a specific real estate asset class, such as multifamily housing, office buildings, cell phone towers, and everything in between.
Investors should choose the type of real estate they are inclined to have. Check their brokerage account, decide which REITs are experts in that asset class, and invest in those.
Investors purchase shares in a portfolio of office buildings, apartment complexes, or any other type of commercial real estate they deem profitable.
How REITs Operate
When a person buys a REIT, they buy a share of the business that owns and manages income-producing real estate, either a single asset or, more frequently, a portfolio of investments. An important distinction is that the individual investor does not own a stake in the property but the company. The REIT then invests and grows its portfolios with these funds.
REITs will typically have predefined investment criteria. A REIT, for example, may only invest in grocery-anchored retail centers in New York, New Jersey, and the surrounding area.
Understanding the investment parameters of the REIT is critical for any investor thinking about purchasing a share of the company.
The REIT must distribute 90% of its profits to shareholders as dividends.
REIT shares can be bought and sold just like regular stocks. As a result, it is typical for the share price of a REIT to fluctuate throughout the day as trading takes place.
What Counts as a REIT?
A business must fulfill the requirements listed below to be considered a REIT:
• Real estate must account for at least 75% of total assets.
• Rents and property sales must account for at least 75% of the company’s gross income.
• Must pay out at least 90% of profits in dividends to shareholders.
• Must have at least 100 shareholders, no more than 50% of total shares held by five or fewer investors; and
• Be organized as a taxable entity with a board of directors or trustees.
Having at least 100 investors is the biggest obstacle some real estate corporations must overcome to obtain REIT status. Consequently, many real estate businesses will start as management firms before changing their structure to become REITs.
Types of REIT: A Comparison
Equity REITs, Mortgage REITs, and Hybrid REITs are the three main types of REITs.
The Equity REITs
Equity REITs purchase, own and manage income-producing properties such as multifamily buildings, retail centers, and office parks. Equity REITs differ from other equity investments in that the companies typically purchase and hold their assets over a long time. Equity REITs attract investors who want the benefit of both long-term capital gains and dividends in the interim.
The Retail REITs
Retail real estate investment trusts (REITs) manage and own retail properties and generate revenue by renting out space in those properties to tenants. The large malls, grocery-anchored shopping developments, and big-box-anchored retailers are part of this real estate investment trust segment. Net lease REITs typically own individual properties and structure leases, so tenants pay monthly rents and most operating expenses for a given property.
The Residential REITs
Residential real estate investment trusts (REITs) manage and own various types of residences and rent out space within their properties to residential tenants. These REITs include single-family homes, manufactured homes, multifamily apartment complexes, and student housing. Some Residential REITs will also concentrate on particular property types or geographic regions, such as single-family homes in the Bay Area of San Francisco or multifamily housing in Tampa, Florida, within the broader context of Residential REITs.
The Office REITs
This subcategory of real estate investment trusts constructs, manages, and maintains office buildings, then leases those spaces to businesses using the offices for office-related business activities. Some companies own the office buildings where they are located outright. Most rent space from office REITs and other landlords, who are well-represented in downtown and other central business districts.
The Healthcare REITs
Medically oriented tenants rent to healthcare REITs, which manage and own healthcare-related real estate and properties. The following are some common examples of healthcare REIT properties:
• Nursing homes and assisted-living facilities
• Medical offices and office buildings
• Healthcare facilities.
• Physical therapy clinics.
How to Make an Investment in Equity REITs
Equity REITs provide investors with access to large, diverse portfolios of income-producing properties and assets that they would not be able to access as individual investors. Listed REITs are currently included in over 250,000 401(k) plans, as well as the personal holdings of approximately 145 million American investors via 401(k)s and other investment plans.
They allowed investors to access REITs with a button on their Charles Schwab, Robinhood, or other brokerage account or platform.
The Mortgage REITs
On the other hand, Mortgage REITs are corporations that make loans to real estate developers. Indirect real estate ownership is what mortgage REITs do. Mortgage REITs frequently acquire existing mortgages or mortgage-backed securities. Mortgage REITs earn money by repaying the interest on these loans.
Investing in Mortgage REITs
Mortgage-backed securities and mortgages are assets that mREITs hold on their corporate balance sheets and use to finance debt and equity capital investments. Usually, their objective is to make a profit from their net interest margin or the difference between their funding costs and interest income on mortgage assets. They rely on various funding sources, such as standard and preferred equity, structured financing, long-term convertible debt, repurchase agreements, and other credit options.
Furthermore, they raise both equity and debt in public capital markets. Compared to other major investors in the sector, mREITs typically use more equity capital and less borrowing to finance the acquisition of mortgages and mortgage-backed securities.
The Hybrid REITs
As its name suggests, a hybrid REIT is a combination of equity and mortgage REITs, making it the third type of REIT. Hybrid REITs will directly own real estate and land to others or invest in other people’s loans.
Investing in Hybrid REITs
As previously stated, REITs are classified into three types: equity, mortgage, and hybrid. Each REIT market segment is divided into holdings-based categories, with the hybrid category combining the equity and mortgage categories. The three main hybrid REIT categories are private, publicly traded, and public non-traded REITs. Usually, one must be an accredited investor or institutional investor to invest in a private REIT.
People can buy publicly-traded REITs from traditional brokers or online platforms such as Robinhood or Webull. Through a broker, investors can purchase public non-traded REITs.
Through conventional brokers or online marketplaces like Robinhood or Webull, people can buy publicly-traded REITs. A broker can provide investors with access to public non-traded REITs.
REIT Definition: Traded Vs. Untraded
REITs are classified into two types: traded and untraded.
The Traded REIT
Publicly traded REITs can be bought and sold on the stock market through brokers, subject to standard brokerage fees, and are registered with the SEC.
Investors can invest in REITs, such as standard or preferred stock or debt.
The Risks of Publicly Traded REITs
Like any other investment, REITs pose some risk to your portfolio. These risks differ from equities or traditional real estate assets—a look at some of the most common dangers in the publicly traded REIT space.
The Interest Rate Risks
Since higher interest rates will result in less demand for REITs, high-interest rates are a curse for these investments. When interest rates rise, most investors seek safe(r) investment options such as US Treasuries such as bonds, treasury notes, or bills.
Investment capital can flow into bonds when interest rates rise. The short- and long-term outlook is less specific because these options are backed by the United States government’s faith and credit and pay a fixed interest rate.
Although a rising interest rate indicates the economy’s underlying strength and consequently lowers the risk of tenant default or property depreciation, is not historically been the case.
In Choosing the Wrong REIT
Another risk, which applies to almost any investment, is picking the wrong REIT. In the early 1990s, picking Enron or Worldcom may not have been the best move toward financial freedom. To determine which REIT might have the best future return potential. Similar to investing in long-distance service, it may have been a bad idea at the dawn of the cellular phone age.
For instance, a large-scale retail mall investment might not yield expected returns in light of the myriad threats facing them, including the post-Covid world, people’s growing aversion to crowded spaces, the rise of eCommerce, and firms like Amazon.
The Tax Treatment
It would be best to consider how REIT dividends are taxed even though it’s less risk and a regulatory fact. Dividends from REITs are taxed as ordinary income. It means that REIT dividends are not taxed as investment income but rather at your income tax rate.
Untraded REITs differ from publicly-traded REITs. They lack liquidity; once an investor places their money, they may not be able to sell their shares.
However, some non-traded REITs have share buy-back provisions. Still, these programs are frequently offered at the discretion of the REIT’s management, can be canceled at any time, and thus cannot be relied on for liquidity.
The not traded REIT
Since there is less liquidity than in publicly-traded REITs, it may be impossible for investors to sell their shares after they have invested their money.
Even though some non-traded REITs have share buy-back provisions, these policies are frequently determined by the management of the REITs. They are subject to cancellation at any time and cannot be relied upon for liquidity.
The Risks of Untraded REITs
Untraded REITs, also known as non-publicly traded REITs, are not limited to accredited or institutional investors. However, this “access for all” comes with a few unique risks for this type of REIT.
The Share Value
The procedure is not as simple as logging into your Charles Schwab account and selecting a share, even though untraded REITs are accessible to most investors. Including liquidity, fees, and other topics we’ll discuss, the share values of these REITs are generally less transparent than those of traditional REITs or other real estate investments.
Insufficiency of Liquidity
In contrast to many standard REITs, untraded REITs are illiquid investments that can’t sell at the market. As a result, investors must wait for the untraded REIT to be listed on an exchange or sell its assets, which may take ten years after the initial investment.
Untraded REITs typically allow investors to redeem their shares early. However, these share redemption options are generally subject to significant restrictions. The REIT can terminate them at any time. They may require that any shares redeemed early be liquidated at a discount, potentially resulting in investor losses.
The Distributions
Rigid distributions for untraded REITs, similar to the lack of liquidity mentioned above, and withdrawing your investment can result in capital loss.
Untraded REITs are exempt from the requirement of allowing you to withdraw funds from the trust. You are causing problems for investors who need access to that money in an emergency or want to invest in a more profitable opportunity.
The Fees
Untraded REITs frequently impose high upfront fees to cover their selling and administrative costs and pay the companies or people selling the investment. Because there is less money available for the REIT to invest due to these fees, which can amount to up to 15% of the offering price, your investment will have a lower value and yield. Untraded REITs frequently have high transaction costs, such as asset management and real estate acquisition costs.
How do REIT fees work?
The extent to which REITs incur fees compared to crowdfunding or other similar options is a common source of concern.
The best comparison for REITs is that the fees will typically be the same as what you would pay any broker for other stock investments.
These fees, which can reach up to 9–10% in non–traded REITs, immediately and significantly lower the investment’s value.
Because crowdfunding is still in its infancy, comparing costs to something like REITs that are more established is difficult.
In both situations, investors must frequently delve deep into the offering documents to learn the full scope of the fees involved. Fees in real estate crowdfunded deals can also be substantial.
How Can You Profit From a REIT?
The stock, or equities, markets are the best analogy for illustrating how you can profit from a publicly owned REIT. Holders receive a dividend from the REIT’s profits, much like people who own shares of Coca-Cola, JP Morgan Chase, or Texas Instruments. Furthermore, they benefit from any increase in the REIT’s value while you hold it, assuming you sell.
Keep in mind that not all REITs will conform to these facts; just as it is possible to purchase shares in poorly run businesses, so is this true of REITs. Before investing, do your homework to learn about the REITs’ investment strategy and the experience and credentials of the team in charge if you want to see a return of at least 5% but preferably more.
Various REIT types may impact your investment’s profitability and volatility. Due to the disproportionate impact that mortgage rates can have on mortgage REIT performance, equity REITs, for instance, tend to be less volatile than mortgage REITs.
You should also be aware of the tax rules and benefits of each REIT type. Recall that 90% of a REIT’s net earnings must be distributed annually to shareholders; this can reduce your tax liability and boost your investment’s yield.
You can choose to deduct up to $3,000 in losses from your taxable income if your investment in a REIT is a loss maker, which can use to offset other gains or income. In real estate markets, as with most investments, your capacity to profit is greatly influenced by market forces, your diligence, and your capacity for foresight.
The Average Return of REITs
The Russell 1000 large-capitalization stocks underperformed the FTSE NAREIT All Equity REITs index among stock market indices. Throughout the 20 years ending in December 2019, according to Nareit, the National Association of Real Estate Investment Trusts.
The annual return on REIT indexed investments was nearly double that of the Russell 1000, at 11.6 percent versus 6.29 percent for stocks. According to data gathered by Nareit, equity REITs had total returns in 2019 of 28.7%, while mortgage REITs had full returns of 21.3%.
Can a REIT Cause You to Lose Money?
Investing in a REIT carries the risk of financial loss. Poor management, the wrong approach to investing in real estate, high fees, tax complications, or any other issues with any financial investment may be to blame for this.
Do not forget that “past performance does not guarantee future results.” As with any investment, you must conduct in-depth due diligence before deciding.
The Benefits and Drawbacks of REITs
Few common factors to consider, even though each investor and REIT will have particular circumstances.
For starters, REITs allow investors to establish a foothold in various specialized and nontraditional real estate types.
For instance, one of the biggest REITs on the market focuses on owning cell towers.
You would be surprised at the variety of properties represented, including billboards, jails, senior housing, etc.
Many of these investments are otherwise inaccessible to investors.
It complements another REIT benefit, giving small investors access to a robust, diversified portfolio.
The Disadvantages of REITs
Before investing, it is critical to understand not only the benefits and potential upside but also the drawbacks and potential downside. It will help you defend your wealth from downturns and allow you to sleep better at night, knowing you’ve done everything possible to protect yourself.
Here are a few drawbacks that REITs present.
The Illiquid
Some REITs are illiquid investments, such as untraded/non-traded REITs or some private REITs. They are typically unable to be sold on the open market, which could present problems if you need to sell quickly to raise money or make another investment.
The Heavy Debt
By their very nature, REITs have a lot of debt and are frequently among the most indebted businesses on the market. It is mitigated partly by the fact that REITs have long-term contracts that generate consistent cash flow, such as tenant leases. It guarantees that REITs can support debt payments and continue to pay dividends to investors.
Low Growth
Keep in mind that REITs primarily distribute their profits through dividends. As a result, to expand their business or portfolio, they must raise funds by issuing new bonds or stock shares. Investors do not always want to buy, as was the case during the recession of 2008 or other similar recessionary periods. Low growth may result from the fact that REITs are less able to take advantage of falling real estate prices than different real estate market segments.
The Tax Burden
REITs do not pay taxes, but dividends received by REIT investors are taxed. An IRA or other tax-advantaged account combined with a REIT investment is one way to avoid this.
Non-Traded REITs Can Be Expensive
Non-traded REIT of your initial investment may often (but not always) reach $25,000 or more. It may only be available to accredit or institutional investors.
They might charge high fees that would consume your initial capital investment and reduce your returns by using the tremendous power of compound interest in the opposite direction.
The Benefits of REITs
Still, there are more benefits that investors can get from REITs.
The Steady Dividends
As the highest dividend-yielding stock market offerings, REITs typically stand out from the competition because they must distribute 90% of their annual income as dividends to shareholders. It is fantastic for investors seeking a steady income stream. Many of the most established and dependable REITs have a history of paying sizeable dividends over an extended period.
High Profits
As we previously discussed, REIT returns have the potential to perform better than stock index returns. Sometimes, even more than doubling particular important stock market performance indicators like the Russell 1000.
Reduced Volatility
REITs frequently exhibit lower volatility than stocks due to higher dividends. Additionally, they frequently exhibit lower volatility for investors than other market segments, such as the tech sector. Although there is no assurance here, it is a factor to consider.
The Liquidity
It’s simple to buy a publicly-traded REIT by researching, calling your broker to have them place the order, or using an app. Purchasing, managing, and maintaining commercial properties on your own is much more demanding. Frequently necessitates specialized knowledge that many investors cannot acquire or do not wish to do so.
Premium for Liquidity
The “liquidity premium” is another factor influencing the decision to invest in a REIT.
The sum an investor is willing to pay above a non-liquid asset’s actual value, such as real estate. In exchange for turning that investment into a liquid asset is known as the liquidity premium.
To put it another way, shares of a REIT are liquid assets because they can be bought and sold immediately. Unlike commercial real estate, which is illiquid because it can take months to sell a building. It is a significant benefit of investing in real estate via a REIT.
Nonetheless, the liquidity premium may also be considered a drawback.
REITs Function like Stocks
Publicly-traded Real Estate Investment Trusts (REITs) are subject to market volatility. In contrast, direct investments in real estate projects are not. Another distinction between investing in REITs and investing in a crowdfunded syndicated real estate deal.
Stock prices fluctuate from day to day and month to month.
Due to the nature of the market, prices may increase or decrease more than the actual value of the underlying assets. In some cases, you would not see with existing physical properties.
It could result in a “double whammy,” If the market falls, your stock falls, and so does your dividend.
During the 2009 financial crisis, the REIT index dropped by more than 80% on a massive scale.
In hindsight, everything looks different, and during the financial crisis, panic drove down the value of REITs far too much.
The bearish stock market at the time and investors’ ability to quickly sell their shares made REIT values collapse even more painful for them.
The actual property values themselves did decline, but not by the complete 80% that was reported.
People used the freedom to sell more quickly than necessary because they could do so easily, which put undue downward pressure on the prices of publicly-traded REITs.
How to Evaluate a REIT
When evaluating a REIT, there are several factors to consider.
-A REIT is a total return investment, which means that it offers investors high dividend yields in addition to a moderate rate of long-term capital growth. Investments in businesses that can deliver both of these advantages are ideal.
– Contrary to most other real estate assets, many REITs trade on stock exchanges. It increases your level of liquidity and, in many cases, allows you to withdraw your money whenever you need to, usually without incurring onerous fees or holding requirements.
Property depreciation frequently exaggerates the decline in the total value of a given investment’s real estate. Therefore, when evaluating a REIT, instead of using a payout ratio, which is what most dividend investors do, look at its FFOs, or “funds from operations.” Calculated as the REIT’s net income less the proceeds from the sale of a property in a given year, including depreciation. It can divide the dividend per share by the FFO per share, keeping in mind that high yields are desired.
-Management is essential. Seek out companies with a good reputation or teams with a long and spotless track record in the industry.
What REITs should I look at and invest
The selected REIT is influenced by a few significant factors, similar to the stock market, such as your time horizon for withdrawing your investments for retirement or starting a business. Investing in other assets, your tax situation, and risk tolerance can be used.
For example, someone looking for long-term returns might look for a medical REIT, hoping to profit from retiring baby boomers moving into care homes. Someone looking for short-term returns might look for multifamily/single-family-focused REITs, hoping to benefit from the COVID-19 rebound. Always exercise caution, tailor your investments to your specific needs, and invest in things you believe.
Our Real Estate Investment Trusts (REITs) Safe During a Recession?
Both, or more precisely, depends on the type of REIT. For example, suppose you have a significant investment in hospitality or restaurant properties. In that case, you may suffer during a recession because people have less money to spend on luxuries.
Although people downsize their homes and move into smaller properties, those who have invested in a multifamily or self-storage REIT may benefit.
Consider the downturn we experienced this past year during COVID-19 compared to previous dips, such as the 2008 crash. During a recession, REITs tend to behave similarly to stocks, with some rising and others falling, emphasizing the importance of long-term planning, due diligence, and diversification.
The Conclusion
REITs provide an alternative to investing in direct acquisition or management of a real estate or investing in syndication through a crowdfunded deal, and they differ in three ways:
1. In terms of price fluctuations, they can behave more like stocks than real estate.
2. Converting an inherently non-liquid asset (commercial real estate) into a liquid asset is likely to incur a liquidity premium, and
3. Investors should pay close attention to REIT management fees, especially non-traded REITs.
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