Should You Be Investing in Real Estate Investment Trusts (REIT) In 2023?
April 20, 2022
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If you're looking for a way to invest in real estate in 2023, real estate investment trusts, REITs, can be a great option. You can invest in real estate without taking on the burden of managing the real estate or even picking the properties.
It's as easy as investing in stocks, and you don't need a lot of capital to start, so even non-accredited investors can enjoy the returns.
What Are REITs?
REITs are real estate investment trusts that are investments in real estate companies that buy, hold, and usually manage commercial real estate. It's a great way to get your foot in the door investing in commercial real estate that's traditionally reserved for accredited investors (wealthy investors).
All REITs carry risk, so it's important to do your due diligence, choose a trustworthy real estate investment company to invest in, and know what investments they're making with your funds.
You have many ways to invest in REITs, including publicly traded REITs and non traded REITs in a variety of industries and categories.
You can invest in REITs in a variety of ways, whether you want to own part of a company's equity or you'd rather be the 'lender' and invest on the debt side of REITs.
Equity REITs give the real estate company and its shareholders ownership of the company. As a shareholder, you earn passive income by investing in the REIT and collecting dividends based on the percentage of the real estate that you own. The REIT company, though, owns, operates, and manages the real estate. Therefore, your dividends and the success of the real estate are in the REIT company's hands.
Equity REITs are a passive investment. You get to participate in the real estate's appreciation, but you don't have to do any of the work involved in running the property.
Mortgage REITs invest in the debt side of real estate. Mortgage REITs buy mortgage backed securities for money lent to real estate developers and builders who want to buy or build up real estate. The REIT company doesn't own the real estate, and you don't earn dividend payments from rental income. However, you may earn dividend income from monthly or quarterly interest payments.
Mortgage real estate investment trusts are often riskier than equity REITs, so that they may pay higher dividends, but that's not guaranteed.
Hybrid REITs are the best of both worlds. The REIT owns and operates real estate (equity REITs) and invests in mortgage debt. This is an excellent way to have a diversified portfolio and take advantage of the many benefits of the real estate market.
Types of REITs
In addition to different categories of real estate investment trusts, there are different types of REITs you can invest in too.
Real estate companies often invest in mortgages because of the high reward. Commercial real estate is often riskier for lenders, so the interest rates paid are higher. As a real estate investor, you have the guarantee of the collateral (the commercial real estate properties) to fall back on should the tenant default.
REITs can invest in office buildings, owning a fraction of the building and earning dividend income on the rents paid. Office buildings are sometimes lower risk than retail buildings and provide a steady income for real estate investors.
Healthcare REITs invest in various healthcare sites, such as hospitals and medical buildings. Since medical facilities will always be in high demand, they can be a good way to diversify a REIT portfolio.
Residential REITs invest in commercial real estate that owns properties to rent out to families. Apartment buildings and hotels are two common examples. Any multi-unit building that the owners can rent out to tenants are residential opportunities for real estate investments.
Retail REITs span the spectrum from freestanding stores to strip malls and large shopping malls. These are the riskiest REIT investments, but because they are income producing real estate, many REITs include at least a few in their portfolio.
How to Invest in a REIT
There are several ways to buy and sell REITs, but the easiest way is on the public stock market. These shares are listed on the stock exchange and available for retail investors to buy or sell shares during regular stock market hours.
There is also the option to buy shares of a REIT as a mutual fund or exchange traded funds if you want a more diversified investment.
The options above are all publicly traded REITs. They are listed on the stock market and registered with the SEC. Publicly traded REITs are bought and sold just as easily as shares on the stock market.
There are also options to invest in private REITs. These REITs usually aren't listed on the stock market and may or may not be registered with the SEC. Instead, you can buy shares through a private brokerage account with a broker associated with the investments.
It's always important to do your research before choosing a REIT. Know the company behind the REIT and its track record. REITs pay dividends often, but it's not a guarantee. Read the fine print and know what you're agreeing to before adding REITs to your investment portfolio.
What to Know About REITs Before Investing in 2023
Choosing to invest in REITs can be a great way to diversify your portfolio, but here are some things you should know before choosing them.
Each investor will have a different 'ideal REIT allocation.' It varies based on your risk tolerance, amount of capital to invest, and timeline. For example, publicly traded REIT stocks are more liquid and allow you to sell them easily should you need to jump out early. But, a non publicly traded REIT may not be as easy to liquidate.
Pay close attention to the fine print, know how long you must be invested, the risk involved when investing in REITs, and how well diversified your portfolio is to determine the right allocation for REIT mutual funds, stocks, and shares in your portfolio.
Assessing REIT Share Values
Publicly traded REITs have a market value based on the activities throughout the trading day. To value shares, companies look at the following:
- The projected growth
- Dividend yields
- The value of the real estate property
- How the property is managed and owned
- Dividend payout ratios
Always find out what investment holdings a REIT has. This could include equity or debt investments, both with different risk factors. A perfectly diversified portfolio would have a combination of debt and equity investments, but only you know what risks you want to take.
REIT Growth Factors
REIT growth factors are an important piece of the puzzle. The highest growth occurs when buildings can increase rents or have more opportunities for occupancy. Another way growth can occur is with the acquisition of more properties as long as they are income producing real estate that can offset the cost of adding to the portfolio.
Not all REITs pay dividends. Always read the fine print and determine if there are REIT dividends and how often they pay them. Some companies don't pay them out but instead reinvest the dividends into the investment. If you're relying on the cash flow, make sure you know how often they might pay.
Fees and Taxes
As with any investment, there are fees. Ask about all fees, including monthly maintenance fees, minimum balance fees, early redemption fees, and commissions.
As far as taxes, dividends are taxable income. Since you pay taxes as you earn money, the dividends you earn this year will be subject to your regular tax rate. In addition, you might also owe capital gains taxes, either short-term or long-term, depending on how long you keep the investment.
Investing in REITs can be a great addition to your portfolio, but understand the fees and how they affect your taxable income before choosing them.
Best Performing REIT Stocks and Mutual Funds: 2023
- Blue Rock Residential Growth REIT - share price $26.51
- Independence Realty Trust - share price $26.96
- Preferred Apartment Communities Inc. - share price $24.89
- T. Rowe Price Real Estate mutual fund - share price $19.50
- JPMorgan Realty Income R5 - share price $16.75
- Low barrier to entry, especially for publicly traded REITs
- Low minimum investment requirements
- Make it easier for anyone to invest in real estate
- Offers great portfolio diversification
- You may earn dividend income
- You can invest in income producing real estate that is usually reserved for accredited or wealthy investors
- There's no guarantee you will have a positive return
- Non traded REITs can be risky because they aren't very liquid
- Some publicly traded and non traded REITs are for accredited investors only
- You have no control over the real estate properties the fund manager chooses
What Is an Appropriate Allocation to REITs?
Every investor has a different allocation to REITs that's right for their portfolio. The right allocation for you depends on your risk tolerance, timeline, and overall financial goals. Whether you invest in publicly traded REITs or private REITs also makes a difference. Non traded REITs are less liquid. If you invest in only publicly traded REITs, you may get your money out faster in a pinch than you would with private REITs.
How Does Age Affect the Optimal REIT Allocation?
The older you get (the closer you are to retirement), the more conservative you need your portfolio because there's less time for market correction. The more conservative you need your portfolio, the higher the allocation of REITs you may want to include in it.
How Do I Find Out What Companies Are REITs?
The REIT directory from the National Association of REITs is a great start to help you find the top REIT companies offering both publicly listed REITs and non traded REITs.
Can You Lose Money on a REIT?
REITs are like any other investment. You can lose money on them. Even publicly traded equity REITs or mortgage real estate investment trust REITs can lose money. There's no guarantee that a property will appreciate, a tenant will pay their rent, or that a company will succeed.
Are REITs Safe During a Recession?
Since REITs invest in real estate, they often do well during a recession. Like most investments, though, you do the best by holding onto the investment for the long term. REITs aren't short-term investments. So you should hang onto them as long as possible to ride out any storms and enjoy the capital appreciation when it occurs.
What Is a Paper Clip REIT?
A paper clip REIT is a real estate company that works in tandem with another company, but they operate under a linked agreement. The other company may not be in real estate, but it's linked to the real estate company for operation purposes.
The Bottom Line
Investing in REITs can be a great way to get into real estate investments today. REITs generate income in the form of dividends and typically appreciate, giving investors capital gains. While there are other asset classes you can invest in, adding REITs to your portfolio is a great way to diversify your investments. Learn more by signing up and visiting our blog.
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