Real estate is one of the most interesting assets one can invest in. Indeed, most people in the Forbes and Bloomberg list of the wealthiest people in the world made their fortune in the real estate sector.
In a previous article, we looked at 6 direct and indirect ways of investing in real estate in the US. We have also looked at the various ways you can invest in real estate in the United States. One of those ways is Real Estate Investment Trusts (REITs).
In this article, we will look at how to invest in REITs, the best REITs to invest in, and the most important terms in REIT investment.
What are REITs
A REIT is a real estate company whose shares are traded in the stock market. This is not enough. REITs are usually different from other stocks that are traded in the market. This is simply because they are managed differently. They also have to meet some requirements to qualify as REITs. In the United States, REITs own more than $3 trillion of assets. They own more than half a million properties in the United States. Publicly listed REITs are worth more than a trillion dollars.
Requirements all REITs Must Have
A REIT must meet a number of requirements. This is because these companies usually have special tax benefits. Some of these requirements are:
- Assets. A REIT must invest at least 75% of its total assets in real estate, cash, or fixed income.
- Income. A REIT must receive at least 75% of its income from real estate rent or from sale of real estate.
- Shareholder returns. A REIT must return at least 90% of all its profits to investors every year. This is done through dividends or share repurchases.
- Shareholder numbers. A REIT must have a minimum of shareholders in its first year. Also, it should have no more than 50% of its shares held by 5 or fewer shareholders.
Are REITs a Good Investment?
A common question in the investment circles is whether REITs are a good investment. There are two sides to this issue. There are those investors who strongly believe in REITs and those who oppose them. Here are a few benefits of investing in REITs.
- High dividends. As mentioned above, REITs are required to return at least 90% of their annual income to shareholders. This means that they have a high dividend yield.
- Alternative way of investing in real estate. REITs offer a good alternative to invest in the real estate sector. With REITs, you don’t need to invest from the ground up.
- Portfolio diversification. REITs help investors balance and diversify their portfolios. This is because returns of REITs are usually uncorrelated to the overall market.
- Long leases. In the United States, income of REITs is usually secured by long leases. For example, retailers like Amazon and Target usually commit to many years.
- Professional management. REITs are managed by professionals who have decades of experience in the industry.
- Returns through appreciation. Property prices tend to appreciate in value over time. This means that investors earn money from dividends and this appreciation.
- Low volatility. REITS usually have very little volatility.
What are the Disadvantages of Investing in REITs?
While REITs are generally good investments, there are those investors who cannot touch them. This is simply because of a number of drawbacks that are common in the REIT industry. Some of these drawbacks are:
- Industry changes. Some REITs are usually sensitive to industry changes. A good example are REITs that focus on malls. These REITs have suffered as people abandon malls.
- Property prices. Some REITs are usually sensitive to changes in property prices. For example, many REITs suffered during the 2008/9 financial crisis.
- Short termism. REITs are required to return money to investors every year. This means that these companies rarely invest in research and development.
- High debt. REITs are usually heavily indebted because of the rule that require them to pay dividends every year.
- Property taxes. REITs pay high local property taxes.
Types of REITs You Can Invest In
Every person who invests in well-selected real estate in a growing section of a prosperous community adopts the surest and safest method of becoming independent, for real estate is the basis of wealth.” – Theodore Roosevelt, U.S. president
As mentioned above, most REITs are traded in the stock market. However, there are other REITs that are not traded in the market. As such, broadly, there are three types of REITs. First, there is Equity REITs. This type of REITs generate income from the collection of rent. They also make money from sale of property.
Second, there are mortgage REITs. These are REITs that invest in mortgages or mortgage securities that are tied to property. This property can be residential or commercial. Third, there are REITs that are hybrid in nature. These REITs combine equity and mortgages.
Categories and Examples of REITs
In the above section, we have looked at the equity and mortgage REITs. In this section, we will look at the key categories that REITs operate in.
Data Center REITs
These are companies that are paid by technology companies to house their data. These companies hire REITs because they don’t want to manage the properties themselves. Examples of data center REITs are: Equinix, CyrusOne, Digital Realty, QTS Realty Trust, and CoreSite Realty. The chart below shows how the Benchmark Data & Infrastructure ETF outperformed the S&P 500 in the past year.
These are companies that provide their buildings to private and public sector healthcare companies. These ETFs are known for their stability because of how big, dynamic, and sensitive the healthcare sector is. Examples of these REITs are New Senior Investment Group, Global Medical REIT, Medical Properties Trust, Healthpeak Properties, and Community Healthcare Trust among others.
As the name suggests, these are REITs that provide property to industrial companies. They provide properties such as warehouses and factories. Examples of these industrial REITs are Terreno Realty Corporation, Liberty Property Trust, EastGroup Properties Group, and Rexford Property Trust among others.
These are REITs that are focused in offering property to companies in the infrastructure industry. Examples of these REITs are American Tower Corporation, Crown Castle International, SBA Communications, and Landmark Infrastructure Partners among others.
These are REITs that provide building to hotels and resorts. Indeed, you have used their services if you have stayed in any of the big hotels. Examples of these REITs are MGM Growth Properties, Summit Hotel Properties, Ryman Hospitalities, and Xenia Hotels and Resorts.
These are REITs that service companies that need office spaces. They serve both the private and public sectors. Examples of these REITs are Easterly Government Properties, Alexandria Real Estate Equities, Piedmont Office Realty Trust, and Hudson Pacific Properties.
These are REITs that provide residential properties. Examples of these are Safehold, Global Medical REIT, and iStar REIT among others.
There are other types of REITS such as retail, diversified, timberlands, self-storage, and mortgage REITs.
How to Invest in REITs
There are a few ways you can invest in REITs. These are:
- Investing in single REITs. This is similar to investing in stocks.
- Investing in a diversified ETFs. This is when you invest in a diversified ETF. Examples of REIT ETFs are Janus Long-Term Care ETF and SPDR Dow Jones REIT ETF among others.
To invest in REITs, you need to conduct a thorough research. This will ensure that you get a good REIT that is also growing. Ideally, REIT investors look at the following:
- The type of REIT. They look at this to know whether it is in a growing or slowing industry.
- Dividend payout ratio. They basically look at the Funds From Operations (FFO) and Adjusted Funds From Operations (AFFO).
- History of dividend growth. They look at the track record of a REIT and how it has grown its returns to shareholders.
- Valuation. Some REITs are overvalued. It is important to invest in growing REITs that are also undervalued.
- Management. The quality of management is very important when considering the REITs to invest in.
In this article, we have looked at basically everything you need to know when investing in REITs. We have looked at what a REIT is, the qualities of a REIT, the types and categories of REITs, and what you need to know when investing in REITs. Still, this is not enough. We recommend that you take time to read a few books on REITs. The ones we recommend are The Intelligent REITs Investor*, Investing in REITs, and The Complete Guide to Investing in REITs*.
Crispus is a finance professional with more than a decade experience in the industry. Over the years, Crispus has written in-depth articles on leading platforms like CCN, Marketwatch, and Seeking Alpha. He also runs a Forex education and managed account company called WestEndFx.