The average investor likely knows there are many ways to invest in real estate.
One of the most popular and effective ways to get started investing in real estate is through a real estate investment trust (REIT).
A REIT is a corporation that invests in real estate on behalf of its shareholders and passes the proceeds on to them.
Let’s start with some introductory topics. What are REITs? How does a REIT work? What types of REITs exist? What are the advantages and disadvantages of investing in a REIT?
Let’s start with . . .
What is a REIT?
A real estate investment trust (REIT) is a corporation who invests in real estate by owning or financing real estate assets.
REITs are required by U.S. law to earn at least 75% of their operating income from real estate, make ownership shares available to investors, and pass at least 90% of their operating income in the form of shareholder distributions.
REITs can have structures, risk profiles, availability, and earnings prospects; still, most REITs can be categorized in two ways.
The first has to do with the type of assets the REIT invests in. Most REITs fall into one of three broad categories: equity REITs, mortgage REITs, and hybrid REITs.
Equity REITs directly own real estate — offices, retail space, apartment buildings, Christmas tree farms, etc. — rent it out, and distribute the proceeds to investors.
Mortgage REITs finance real estate acquisitions by originating or purchasing mortgages and earn returns on interest.
Hybrid REITs invest through both direct ownership and financing.
REITs are also categorized according to how ownership shares are bought and sold.
Public and exchange-traded REITs sell ownership shares on stock exchanges, and distribute dividends to shareholders.
Non-exchange-traded public REITs (sometimes called public non-listed REITs, or PNLRs) aren’t available on national stock exchanges and distribution structure can vary.. But, the SEC oversees and monitors these funds.
Private REITs are neither exchange-traded nor registered with the SEC.
What’s the difference between REITs and private equity?
REITs are corporations that invest in real estate and pass the returns on to shareholders
Private equity real estate investment funds are professionally-managed pools of real estate assets.
Unlike REITs, private equity investments are funded by the contributions of limited partners (LP), and acquired and operated by fund employees.
While many of the largest, most popular REITs are publicly-traded, private equity funds are not. Instead of selling ownership shares on the public market, they manage LPs’ capital, and return the earnings to the LP.
Both non-traded REITs and private equity funds are considered private real estate. Non-traded REITs can sometimes look a bit more like private equity funds depending on how they’re set up, but private equity funds have a different legal status and different regulations.
What are the advantages and disadvantages of REITs?
In general, investments like REITs, that outsource the actual business of real estate investing to professionals, offer a couple of broad advantages over alternatives.
Ease and simplicity. Investing in real estate through direct ownership and operation is a full-time job. It can be lucrative and satisfying, but being a landlord isn’t usually an easy side hustle, or a way to save for retirement, that is sustainable with a full-time career.
Lower risk. Most investors simply don’t have the capital to acquire a lot of properties. Even relatively large “mom-and-pop” investment firms usually own a fraction of the total asset value of most REITs. That means risk is simply more diluted for REITs and similar private real estate investment options.
Professionals. Investing in real estate can be difficult, and buying into a REIT gets a professional team in your corner. Let the professionals tackle tricky problems like acquisition and financing, property management, accounting and tax, maintenance, and legal.
REITs also offer several benefits that are relatively unique in the real estate space.
Accessibility. Investing with an exchange-traded REIT is as simple as buying stock. Pick a REIT you think will perform well, and purchase some shares through a brokerage account or trading app. These investments give a wide range of investors access to one of the best asset classes without complexities associated with direct ownership and operations and private equity funds.
Liquidity. Unlike selling a house, liquidating an investment with an exchange-traded REIT is as simple as selling stock. This kind of liquidity is virtually unparalleled in the real estate world.
Diversification and exposure. Publicly-traded REITs own many asset classes nationally and internationally. Because of their high diversification, large REITs can be more stable in the face of economic risk (such as an unforeseen drop in the price of office space or natural disaster occuring in a particular city).
Large REITs also provide investors the opportunity to earn returns on much higher-quality assets than they could otherwise afford. Most people can’t single-handedly buy a hotel or apartment building. A large REIT can purchase these types of properties and then pass the proceeds on to shareholders.
One of the historic advantages of real estate as an asset class is that it tends to be relatively risk-resilient. People will always need a place to live. Tangible, useful, naturally scarce resources like land have a strong advantage.
Exchange-traded REITs’ stock prices are susceptible to influence from other economic and market forces that might not be real estate-related. An open market creates liquidity, but also risk by increasing the number of participants and transactions, and the scope of events that influence them.
Private REITs can also create large portfolios similar to large REITs, hedging against risk in the same way, while remaining better-insulated against market forces than their exchange-traded counterparts.
But for investors with less capital, limited experience, or who desire liquidity, exchange-traded REITs are an accessible, lower-risk method to invest in real estate.
Non-traded and private REITs offer a somewhat different value proposition and can offer dramatically distinct investor experiences.
A more strategic investment. More exclusive REITs can use a more focused investment strategy. A REIT investing exclusively in Class-A offices or hotels in major East-Coast cities is riskier than one that owns multiple types of properties, but it may also provide better returns by selecting higher-quality assets.
Lower fees. Where private equity funds offer similar advantages in asset selection and returns, they pay expenses via management fees. Investors can sometimes access similar advantages for a better rate with REITs. REITs may also offer more investor-friendly payouts, using monthly distributions instead of more complicated returns structures.
Private REITs will occasionally use fees to fund operational expenses and management costs. Sometimes, the private REIT offers a better value, while at other times the PE fund does. That’s why there’s no substitute for doing your research.
Finally, private and non-listed REITs are often available only to institutional or accredited investors. For investors in those categories, they can be compelling investment options, but they’re generally less accessible than their publicly-traded counterparts.
Conclusion
Real estate investment trusts (REITs) are a great way to diversify your portfolio in an accessible way. A REIT is a corporation that invests in real estate on behalf of its shareholders and passes the proceeds on to them. REITs can be private, public, traded on a stock exchange, or non-traded.
As always, we encourage investors to conduct research to determine which real estate investing option best suits their financial goals and investment strategy.
