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REITs historically have provided competitive returns and dividend yields higher than the average yield of S&P 500 funds. Investors also benefit from long-term capital appreciation. For many investors, REITs make an excellent addition to a portfolio, but no investment is risk-free. Here’s what you need to know to get started investing in REITs and what you should keep in mind before you invest.
How to invest in REITs
The process to begin investing in REITs depends on the type of REIT you want to invest in.
Publicly-traded REITs
Invest in publicly-traded REITs by purchasing shares through a broker, just as you would a stock. These are traded on major stock exchanges just like other stocks and ETFs.
- Sign up with a broker. Compare brokers by fees, commissions, reliability and educational tools and resources. When you’re ready to sign up, you’ll typically need to provide your personal information like your name, address, date of birth and Social Security number. You’ll also need to connect a bank account to fund your new brokerage account.
- Decide on a REIT to invest in. Search for and choose a REIT, a REIT mutual fund or a REIT exchange-traded fund (ETF) as you would a stock or other security.
Public non-traded REITs
With the proliferation of real estate crowdfunding platforms like Fundrise and DiversyFund, you can invest in public non-traded REITs online and with fewer fees than before.
- Choose a crowdfunding platform. Start by researching real estate crowdfunding platforms that offer REIT investment opportunities. Compare them based on factors such as annual fees, available fund types and minimum investment requirements.
- Select an investment. Some platforms provide a single diversified fund, while others offer a range of investment tiers, each with its own risk profile and minimum investment. Choose one that aligns with your financial goals and budget.
REIT tax considerations
REIT shareholders are responsible for paying taxes on the dividends they receive and on any capital gains if a REIT sells any of its assets. Since these dividends are treated as ordinary income, consider purchasing REITs from your tax-advantaged retirement account to defer income tax on the gain. While you won’t avoid paying tax, you can defer paying taxes on the dividends you receive and any capital gains incurred until you start withdrawing money from your account.
Some crowdfunding platforms let you purchase public no-traded REITs via IRAs.
How to analyze a REIT
With over 200 REITs in the FTSE Nareit All REITs Index to choose from, compare the following six factors before you invest:
- Market segment types. Through your research, decide which types of properties you expect to perform well. Don’t base your decision solely on how well a segment did last year — markets that lost value last year may be poised for a comeback.
- How dividends are treated by the IRS. Most REIT dividends are not IRS “qualified dividends” and are taxed at ordinary income tax rates. Consider purchasing REITs from your tax-advantaged retirement account to defer or avoid income tax on the gain.
- How the REIT is traded. Publicly-traded REITs are the simplest type of REIT to buy, though crowdfunding platforms have made it easier to invest in public nontraded REITs as well.
- Funds from operations as an indicator of yield. For companies invested heavily in real estate, depreciation expense tends to make it appear they are losing asset value when they may not be. A more useful way to compare REIT yields may be to look at funds from operations, defined as net income less any sales of property and depreciation. It’s the actual amount of cash flow generated from the company’s business operations.
- Historical rates of return. Look for companies with a solid track record. Consider long-term trends, and not just last year’s results.
- Time in existence. A new, unproven company may be a riskier investment. There are always exceptions, but companies that have been in existence for decades or longer tend to stay in business. On the other hand, newer companies often have high growth potential along with higher risk.
How do REITs work?
A REIT typically owns and operates income-producing real estate or real estate-related assets. These can include, but are not limited to:
- Office buildings
- Shopping malls
- Apartment complexes
- Hotels
- Resorts
- Self-storage facilities
- Warehouses
- Mortgages or loans
- Data centers
- Healthcare facilities
- Cell phone towers
- Infrastructure
REITs can be publicly-traded, public but non-traded, private, as well as through ETFs and mutual funds.
Publicly-traded REITs are registered with the US Securities and Exchange Commission (SEC) and are traded on the stock market. Non-traded REITs are registered with the SEC but don’t trade on stock exchanges. Other REITs are private and are typically only sold to accredited investors.
Income generation
Most REITs generate income through interest payments on real estate financing or mortgages or by leasing space and collecting rent. When you buy shares in a REIT, your shares represent ownership stake in the company, and you’re entitled to receive a share of the income produced in the form of dividends. REITs are required to pay out at least 90% of their taxable income to shareholders to maintain their status with the Internal Revenue Service (IRS). They also don’t pay taxes at the corporate level, which can mean a higher dividend payout for investors. This high, steady dividend income makes REITs a favorable investment strategy for long-term investors.
But since REITs pay out most of their profits in the form of dividends and don’t pay a corporate tax, there are certain tax consequences for investors. Namely, REIT dividends don’t qualify for the lower rate that most dividends typically qualify for. Instead, investors are taxed at their individual tax rate, the same rate as ordinary income.
REITs offer a unique approach to investing in real estate and are valued for the income they provide. One of the main advantages of buying REITs instead of investing in real estate directly is the diversification over putting all your capital in one investment.
But for a company to qualify as a REIT, it must operate according to a specific set of rules set by the IRS.
REIT qualifications
Companies must meet the following specific operating requirements to qualify as REITs with the IRS:
- Return at least 90% of income as dividends each year
- Be an entity that’s taxable as a corporation
- Be managed by a board of directors or trustees
- Have at least 100 shareholders after the first year of existence as a REIT
- Have no more than 50% of shares held by five or fewer individuals during the last half of the taxable year
- Invest at least 75% of its total assets in real estate
- Derive at least 75% of its income from real estate — including rents, mortgage interest and real estate sales
5 types of REITs
Here’s a look at the five main categories of REITs.
REIT type | Description |
---|---|
Retail | Shopping centers, malls or freestanding stores |
Residential | Multi- or single-family homes |
Health care | Medical offices, hospitals or senior-living or assisted-living properties |
Office | Office buildings and properties |
Mortgage | Debt securities backed by real estate |
REITs benefits and drawbacks
REITs have several positives but also a few downsides.
Pros of investing in REITs
Investing in REITs can have several benefits, including:
- Portfolio diversification. REITs provide investors with a simple way to diversify their portfolios with real estate. Since REITs span a variety of property sectors — from retail to residential to office space — they can provide even greater diversification.
- High dividends. REITs are legally required to pay out at least 90% of their profits to shareholders. Because REITs can deduct from its income all dividends paid to shareholders, many even pay out 100% of their taxable income.
- Tangibility and capital appreciation. REITs are investments in physical property that can increase in value over time.
- Higher liquidity compared to other real estate investments. Publicly-traded REITs are bought and sold like stocks, so they’re highly liquid compared to buying an investment property.
Cons of investing in REITs
Despite their many benefits, investing in REITs also has its drawbacks.
- Higher taxes. Taxes on REIT dividends can be higher compared to typical dividend-paying stocks because most are taxed as ordinary income. Depending on your tax bracket, this could be as high as 37%.
- Greater volatility. Depending on the sector a REIT is invested in, the investments in the fund can experience dramatic swings due to various external factors — like a global pandemic — or trends specific to the type of property.
- Best suited for long-term investors. Because of this greater volatility, the potential for long-term capital appreciation and the benefits of compounding when investors reinvest their dividends, REITs are generally better suited for investors with a longer time horizon.
Alternatives to REITs
Investing in REITs might not make the most sense for you or maybe they don’t provide the type of exposure to real estate that you’re looking for. Alternatively, you can invest in:
- Rental properties. Rental properties can provide an additional source of income and the potential of capital appreciation. While they require more upfront cash, any additional money after expenses is profit.
- Flips. If you understand your local real estate market and have the time and knowledge to renovate a home, house flipping can provide relatively quick and big returns. But there’s always the possibility of getting stuck with the property and having to pay a mortgage on it until it sells.
- Other real estate investing platforms. Whereas some platforms focus solely on REITs, others take a different approach to real estate investing. For instance, Roofstock lets you invest in single-family rental properties. Yieldstreet, on the other hand, lets you invest in a multi-asset class fund that includes real estate, art, marine financing and more.
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The Finder Score crunches 147 key metrics we collected directly from 18+ brokers and assessed each provider’s performance based on nine different categories, weighing each metric based on the expertise and insights of Finder’s investment experts. We then scored and ranked each provider to determine the best brokerage accounts.
We update our best picks as products change, disappear or emerge in the market. We also regularly review and revise our selections to ensure our best provider lists reflect the most competitive available.
Bottom line
REITs make it possible to invest in real estate without having to purchase and maintain physical properties yourself. They provide historically strong returns based on high dividends and capital appreciation. But taxes can be high compared to other dividend-paying securities, and market conditions can cause dramatic swings in the overall returns of REITs, making REITs ideal for long-term investors.
If you’re looking to take advantage of their significant long-term investment potential, investing in REITs might be an investment strategy worth considering. Compare and open a brokerage account to get started. For individual guidance specific to your own financial situation, consult a financial advisor.
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