If you’ve ever considered purchasing property and becoming a real estate investor but want to skip the headaches of property management and tenant relations, there’s a better way. You can capture all the benefits of real estate ownership without physically acquiring properties through REITs—and here’s exactly how to invest in them.
What Is A REIT?
A real estate investment trust (REIT) is a company that owns and operates income-generating real estate and related assets. These typically include large-scale properties like apartment complexes, medical facilities, gym facilities, office buildings, and hotels. REITs may also hold infrastructure properties with minimal human interaction, such as cell towers, data centers, and warehouses.
REITs operate much like mutual funds. The property portfolio within a REIT gets divided into shares that thousands of investors can purchase, with values fluctuating based on the underlying properties’ performance.
Since most individuals lack the capital to purchase commercial real estate outright, REITs offer an accessible pathway to own these property types without the complexities of direct acquisition.
Like rental property owners, REITs focus on transforming properties into consistent income-producing assets rather than flipping them for quick profits.
Types Of REITs
Four main types of REITs exist:
Equity REITs
These REITs trade publicly on stock exchanges, just like traditional stocks. When people discuss REITs generically, they’re usually referring to equity REITs.
mREITs (Mortgage REITs)
These specialized REITs purchase mortgages or mortgage-backed securities used to finance income-producing real estate.
Public, Non-Listed REITs (PNLRs)
REITs registered with the SEC but not publicly traded on exchanges.
Private REITs
REITs that are neither publicly traded nor SEC-registered.
Why Should You Invest In A REIT?
As mentioned earlier, REIT investing’s primary advantage is accessing commercial real estate ownership.
Just as stocks can outperform market averages for extended periods, REITs can deliver similar results. This proves especially valuable since real estate represents a completely different asset class from stocks and bonds. When traditional assets decline, your REIT holdings might maintain or increase their value, making them excellent portfolio diversification tools.
REITs’ other major appeal lies in their substantial dividend yields. Federal law requires REITs to distribute at least 90 percent of their taxable income to shareholders—most pay out 100 percent!
The average REIT dividend yields approximately 5 percent compared to the average stock’s 1.9 percent. These above-average dividend payments attract income-focused investors seeking maximum returns, particularly retirees.
REITs And Taxes
Due to REITs’ income distribution structure, the IRS taxes their dividend payments as ordinary income (similar to employment earnings). This differs from traditional corporate dividends earned on stocks. Since ordinary dividends aren’t “qualified,” they don’t receive the preferential tax treatment that corporate dividends enjoy—a potential drawback for REIT investors.
Before tax season, the REIT will provide an IRS Form 1099-DIV reporting your dividends and capital gains. You can learn more about REIT taxation here.
How To Choose A REIT
Multiple strategies can help you identify promising REIT investments.
Recommendations
Start by researching highly recommended options, such as these suggestions from Nerd Wallet which receive regular updates. Cross-reference these against recommendations from reputable financial sites like The Motley Fool, Seeking Alpha, and Kiplinger.
Industry Type
Next, select which REIT industry aligns with your investment comfort level. Retail, residential, healthcare, or others? Each sector carries distinct advantages and disadvantages.
Healthcare has experienced growth for several years running. However, operators frequently depend on Medicare and Medicaid reimbursements for revenue. Any modifications to these programs could impact tenants’ lease payment capabilities.
Spend time evaluating each sector’s pros and cons before committing.
Metrics
Like stocks, REITs have key metrics that reveal the asset’s overall health. Familiarize yourself with these essential indicators:
- Price Range – Current share price compared to the 52-week range and volatility levels.
- Funds from operations (FFO) – Net income (equivalent to a stock’s “earnings per share”).
- Price-to-FFO (P/FFO) ratio – Shows how expensive the REIT is relative to competitors (similar to a stock’s “P/E ratio”).
- Payout ratio – Dividend payment as a percentage of earnings.
- Debt-to-EBITDA ratio – The REIT’s debt load.
- Dividend Yield – 12-month distributions divided by current share price. Note that price fluctuations affect yield calculations.
Mutual Funds And ETFs
If you prefer avoiding direct REIT purchases or want diversification across multiple industries simultaneously, there’s a simpler approach.
Just as mutual funds allow you to purchase various stocks and bonds collectively, you can achieve the same with REITs through mutual funds or exchange-traded funds (ETFs). Vanguard offers the Vanguard Real Estate ETF (VNQ), which holds specialized REITs, residential REITs, industrial REITs, and numerous others.
Where To Purchase A REIT
REITs trade on the open market just like stocks. If you have an existing brokerage account, simply log in, conduct your research, and purchase during market hours. Without an account, discount brokers like E-Trade or TD Ameritrade provide excellent platforms for getting started.
For indirect REIT investing through mutual funds or exchange-traded funds (ETFs), consider full-service brokers like Vanguard and Fidelity.
If you need assistance selecting the right REIT ETF, consider using a robo-advisor. These relatively new financial services have investors complete profile questionnaires about their goals and risk tolerance, then match them with appropriate ETFs. Try platforms like Betterment, Wealthfront, and M1 Finance.
You can also invest in public non-listed REITs and private REITs by purchasing directly from the REIT company.
REIT Risks
Like stocks or any financial assets, REITs carry inherent risks. Real estate represents an asset class where demand fluctuates for various reasons.
Consider a hotel-focused REIT during a recession. If hotels generate no income, the REIT’s value will decline. This scenario unfolded during the 2008 real estate bubble when the iShares Dow Jones US Real Estate ETF (IYR) returned -40.03% including dividend income.
Interest rates also significantly impact REIT investments. Low rates benefit REITs as investors gravitate toward these higher dividend-yielding assets. However, rising rates drive investors toward “safer” assets like bonds or other fixed-income securities.
As with all investments, remain vigilant for warning signs. Exercise caution with companies advertising unusually high dividend yields, limited capital access, or excessive debt loads (compared to industry peers). Always analyze the metrics and conduct thorough research before investing.
