July 27, 2022
Mark Twain famously said: “Buy land, they’re not making it anymore.” The quip lands because it points out the obvious. On a more serious note, it also illustrates what makes real estate so attractive: its scarcity and long-term value.
There are many reasons casual investors might shy away from direct real estate investing.
The learning curve for direct real estate investment is steep. Real estate is highly localized, and investors must intimately know their markets. Timing is important with any investment, but it is absolutely critical with real estate. Affordability is a major barrier to real estate investing as well. Most investors don’t have the money to buy a shopping mall or industrial park on their own.
REITs, or real estate investment trusts, can make real estate a lot easier for the retail investor. REITs are companies that own or finance income-producing real estate. While REITs can be a bit easier to digest, they can still be risky investments for the uninitiated. As with any investment, it is best to understand what REITs are and how they work before risking your hard-earned money.
REITs are a specific type of investment and as such, they must meet several criteria. To qualify as a REIT in the U.S., a company must:
Invest at least 75% of assets in real estate, cash, or U.S. Treasuries
Derive at least 75% of gross income from rents, interest on mortgages, or real estate sales
Pay at least 90% of taxable income in the form of shareholder dividends
Be a taxable corporation
Be managed by a board of directors or trustees
Have at least 100 shareholders after one year of operations
Have no more than half its shares held by five or fewer people
Other than that, investing in REITs is very similar to being a shareholder of any publicly traded company. REITs come in a variety of forms. You can invest in exchange-traded funds (ETFs) and mutual funds that hold REITs and some REITs are privately held.
REITs are attractive to some retail investors because just like any stock, REIT shareholders profit by earning a share of the income produced, but without having to buy, manage or finance the property themselves.
Many passive investors probably already own REITs. About 145 million Americans have REIT investments through their 401(k), IRAs, pension plans and other investment funds, according to Nareit, the trade group that leads the U.S. REIT industry. REITs can be small or large, but in total, REITs own more than $3.5 trillion in gross assets. Publicly traded REITs own about $2.5 trillion in assets that include more than 500,000 properties and those listed REITs have a market capitalization of more than $1.35 trillion. REITs must pay out at least 90% of their taxable income to shareholders, though most pay out 100%. Shareholders pay the income tax on those dividends.
Retail investors looking into REITs have many choices of real estate property types to choose from. Some REITs specialize in office buildings, while other specialize in apartment buildings, cell towers, warehouses, infrastructure, retail centers, hotels, medical facilities and data centers.
The two largest publicly traded REITs are American Tower (Tii:AMT), an owner and operator of wireless and broadcast communications infrastructure worldwide, and Prologis (Tii:PLD), which owns warehouses and distribution centers in Asia, Europe and the Americas. But REITs both large and small are publicly traded and include Crown Castle (Tii:CCI) in communication, Public Storage (Tii:PSA) in storage facilities, Equinix (Tii:EQIX) and Digital Realty (Tii:DLR) in data centers, Simon (Tii:SPG) in malls, Welltower (Tii:WELL) in healthcare, Realty Income (Tii:O) in commercial real estate and AvalonBay Communities (Tii:AVB) in residential real estate, to name just a few.
Retail shareholders can also invest in mREITs. The “m” stands for mortgage. These companies finance real estate and earn income from the interest on the investments. Some of the largest mREITs are Annaly Capital Management (Tii:NLY), Starwood Property Trust (Tii:STWD) and AGNC Investment Corp. (Tii:AGNC).
Since real estate usually does not move in exactly the same direction as the stock market, some investors use REITs to diversify their portfolios.
REITs are one way of investing in real estate without the headaches of purchasing traditional real estate.
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