If you’re looking for a way to diversify your portfolio and get involved in real estate investing, there are a multitude of options. And as is usually the case with investing, choosing the appropriate strategy is all about balancing the risk and the reward.
For some people, investing outright in a piece of real estate – like a rental property – isn’t financially feasible or desirable. Thankfully, there are other ways to expose your portfolio to real estate and enjoy some of the upside of this part of the economy. REITs are one option.
A real estate investment trust, or REIT, is basically a real estate investment company that owns, operates, and manages income-producing real estate like single-family rental properties, office buildings, warehouses, strip malls, or healthcare facilities.
Rather than only relying on their own money, REITs allow anyone to invest in their portfolio of real estate assets in the same way that people invest in companies by purchasing individual stocks. When you invest in a REIT, you share in the income that it produces without having to buy real estate or put your name on a title.
From an individual investor’s perspective, REITs are extremely simple and easy to understand. The company/fund owns a portfolio of income-producing real estate. The income that is generated is paid out to shareholders as dividends. By law, they are required to pay out a minimum of 90 percent of their taxable income (though most pay out 99 to 100 percent).
The power of REITs is found in numbers. REITs don’t just have one, three, or five properties in their portfolios – they have hundreds or thousands of individual units. This spreads out the idiosyncratic risk and makes them relatively safe investments (which can’t always be said when you’re investing in a single income-producing property where any number of things could go wrong).
While most REITs are fairly similar in their structure, different real estate investment trusts invest in different types of assets. Here are some of the most common ones:
Did you know that 24 percent of REIT investments are in freestanding retail and shopping malls? This makes it the single-largest investment type in the United States. In fact, the majority of all shopping centers are owned by REITs.
While retail REITs are (and have been) relatively healthy investments over the years, there is some long-term concern about this sector as more shopping moves online and physical storefronts become less important. That being said, retail REITs are generally a good addition to any portfolio.
With office REITs, the company invests in commercial office buildings and generates rental income from tenants who sign long-term leases. Much like retail REITs, nobody knows what the future will hold with remote work and virtual work, but finding solid funds in economic strongholds like Washington D.C., New York, San Francisco continues to be a good practice.
With residential REITs, the company usually owns and operates multi-family rental apartment buildings. A single REIT might own thousands of “doors” in different cities and states across the country. However, the biggest and most successful residential REITs are usually focused on large urban centers. Long-term, the outlook is pretty strong for this type.
Many REITs niche down to very specific types of properties. For example, there are healthcare REITs that focus on medical centers, hospitals, nursing facilities, and retirement homes. By specializing in these types of properties, the investment team is able to make very targeted and educated investments that (ideally) produce a higher than average return based on their knowledge and experience.
Roughly 10 percent of all REIT investments are in mortgages (rather than the actual real estate). Common examples include Freddie Mac and Fannie Mae. With these companies, the REIT invests in the mortgages, not the actual asset or equity. As interest rates rise, mortgage REIT values decline (and vice versa).
People invest in REITs for any number of reasons. Some of the most enticing benefits include:
REITs aren’t perfect. (No investment is.) Here are some of the potential negatives and drawbacks:
There’s no such thing as a risk-free investment. Real estate investment trusts, like any other investment, come with their own set of risks and rewards. It’s up to you to calculate your own risk tolerance and weigh it against your financial goals.
Generally speaking, most savvy investors like to diversify with REITs (rather than relying on them for the bulk of a portfolio). When plugged in alongside stocks, mutual funds, ETFs, bonds, cryptocurrency, insurance products, and other real estate investments, REITs are a great option.