How Do REITs Work and the Different Types

REITs, or Real Estate Investment Trusts, are a type of investment that allows individuals to invest in real estate without directly owning physical properties.

REITs work by pooling money from multiple investors to purchase and manage income-generating properties, such as office buildings, apartments, and shopping centers.

These properties generate rental income, which is then distributed to the REIT's shareholders.

REITs are traded on major stock exchanges, making it easy for individuals to buy and sell shares.

There are several types of REITs, including equity REITs, mortgage REITs, and hybrid REITs, each with its own unique characteristics and investment strategies.

Equity REITs, for example, focus on directly owning and managing income-generating properties, while mortgage REITs focus on lending money to real estate developers and property owners.

Hybrid REITs, on the other hand, combine elements of both equity and mortgage REITs, offering a more diversified investment portfolio.

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A REIT, or Real Estate Investment Trust, is a company that owns, operates, or finances income-producing real estate. Created by a 1960 law, REITs were designed to make real estate investing more accessible to smaller investors.

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REITs allow you to earn income from real estate without having to buy, manage, or finance properties yourself. They pool capital from many investors to invest in a portfolio of properties, such as skyscrapers, shopping malls, or apartment complexes.

To qualify as a REIT, a company must meet several requirements set by the Internal Revenue Service (IRS). Here are some of the key requirements:

Healthpeak Properties Inc. (DOC) is an example of a REIT, an S&P 500 company that owns, manages, and develops healthcare real estate.

There are three main types of REITs: Equity, Mortgage, and Hybrid. Equity REITs make up the majority of the market, accounting for 96% of the market share in 2023.

Equity REITs own and manage income-producing real estate, generating revenues primarily through rent. They're the most common type of REIT, and their shares are typically publicly traded.

Mortgage REITs, on the other hand, lend money to real estate owners and operators through mortgages and loans, or by acquiring mortgage-backed securities. They earn income from the interest on these investments, but are sensitive to interest rate increases.

Here's a breakdown of the different types of REITs:

Types of REITs can be categorized based on the types of properties they invest in. Equity REITs own and manage income-producing real estate, generating revenues primarily through rent.

The majority of REITs, around 96% in 2023, are equity-based. They own and operate a variety of commercial properties such as shopping malls, office buildings, and data warehouses.

Mortgage REITs, on the other hand, lend money to real estate owners and operators directly through mortgages and loans or indirectly through acquiring mortgage-backed securities.

Hybrid REITs mix strategies from both equity and mortgage REITs, but they have largely disappeared since the 2007-2008 financial crisis due to changing regulations.

Here's a breakdown of the different types of REITs:

Public Non-listed REITs and Private REITs are other types of REITs that are registered with the SEC but do not trade on national stock exchanges, and are exempt from SEC registration respectively.

Retail REITs are a type of investment that can be affected by the retail industry's cash flow problems.

As of May 31, 2024, there are approximately 28 retail REITs on the FTSE Nareit U.S. Real Estate Indexes.

Retailers with poor sales may delay or default on rent payments, making it difficult for REITs to find new tenants.

Anchor tenants like grocery and home improvement stores are more likely to have strong cash flow and be less likely to default on payments.

REITs with good profits, strong balance sheets, and minimal debt will be better equipped to handle economic downturns.

In a poor economy, retail REITs with significant cash positions can take advantage of buying good real estate at distressed prices.

However, the retail REIT space is under pressure due to the shift towards online shopping and the need to innovate and fill space with non-retail tenants.

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Investing in REITs can be done in several ways, including buying shares in a publicly traded REIT, a REIT mutual fund, or an exchange-traded fund (ETF). You can also invest in public non-listed REITs and private REITs, but be aware that these options are less liquid and often subject to stricter regulations.

To buy shares in a REIT, you'll need to open a brokerage account or invest through your workplace retirement plan. This process typically involves providing basic contact details, income information, and occupation data. Once your account is open, you can use online education and research tools to review possible REIT investments and select the one that best fits your financial needs.

REITs offer a range of benefits, including high-yield dividends, diversification, and a hedge against inflation. However, not all REITs are created equal, and some may focus on specific sectors of properties or invest in real estate debt. To get started, consider beginning with a modest allocation and gradually increasing your exposure over time, scaling up to 5% to 15% of your portfolio, depending on your financial goals and risk tolerance.

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To invest in REITs, you can buy shares in a REIT listed on a major stock exchange, just like any other public stock. This can be done through a brokerage account or a retirement plan.

You can also invest in REIT mutual funds or exchange-traded funds (ETFs), which offer a more diversified portfolio. These funds are managed by professionals who select and adjust holdings to capitalize on market trends or mitigate risks.

Publicly traded REITs are listed on a public exchange, where they are bought and sold by individual investors. They are regulated by the U.S. Securities and Exchange Commission (SEC) and are considered a liquid investment.

Private REITs, on the other hand, are not registered with the SEC and do not trade on securities exchanges. They are often sold only to institutional investors and can be a higher-risk investment.

To get started with investing in REITs, you can begin by investing a small percentage of your portfolio, such as 2% to 5%, in a broadly diversified REIT or REIT fund. You can then gradually increase your exposure over time as you become more familiar with the real estate market.

Here are some options for investing in REITs:

Monthly Payment Options are a key consideration for income-focused investors.

Some REITs do offer monthly payments, but it's not a universal practice. Most REITs pay quarterly, while others pay annually or semiannually.

Monthly payments can provide a steady income via dividends, which can be attractive to investors seeking regular cash flow.

However, the frequency of payments doesn't necessarily indicate higher returns or better financial health for the REIT.

REITs typically pay higher dividends than common equities, often due to their favorable tax structure and ability to generate income from real estate properties.

One of the main benefits of REITs is their potential for higher yield, making them an attractive option for investors seeking passive income.

REITs can provide diversification benefits by following the real estate cycle, which typically lasts a decade or more, whereas bond- and stock-market cycles last an average of roughly 5.75 years.

However, REITs are also subject to real estate risk, including fluctuations in property value, leasing occupancy, and geographic demand.

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In addition to real estate risk, REITs are sensitive to changes in interest rates, which can affect property values and occupancy demand.

Lower rents and occupancy rates can negatively impact REITs, making it essential for investors to understand these risks.

Here are some of the key risks associated with REITs:

Despite these risks, REITs can also offer a hedge against rising inflation rates, particularly those with commercial holdings that have agreements to raise rents in tandem with inflation.

To buy and own REITs, you have several options. You can buy shares of publicly traded REITs through a brokerage account, which is the easiest way to get started.

Publicly traded REITs have a relatively low cost of entry, with most trading below $100 a share. This makes it accessible to newcomers.

You can also invest in a mutual fund or exchange-traded fund (ETF) focused on REITs, which provides broad diversification across the REIT sector. These funds are easy to buy and relatively inexpensive to purchase.

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Here are some strategies to consider when investing in publicly traded REITs:

Investing in public non-traded REITs through a financial advisor or real estate crowdfunding portal can be more challenging, with higher minimum investments usually starting at $2,500 or more.

To buy a REIT, you can start with publicly traded REITs, which offer the easiest way to get started, with no minimum investment requirements beyond the share price.

You can buy shares of publicly traded REITs through a brokerage account, and most REITs trade below $100 a share, making them relatively inexpensive.

Publicly traded REITs are a great option for newcomers, as they don't require a vast amount of money to get started.

To invest in publicly traded REITs, you'll want to do your homework, examining the REIT's portfolio, management team, debt levels, and dividend history before investing.

You should also think of the long-term when investing in REITs, as they are customarily best suited for long-term strategies because of how they generate income.

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REIT management fees are built into operating expenses, affecting your overall returns, so it's essential to review how efficiently the trust is managing its expenses.

Here are some strategies to consider when investing in publicly traded REITs:

You can also invest in a mutual fund or exchange-traded fund (ETF) focused on REITs, which are easy to buy and relatively inexpensive to purchase.

Another option is to invest in public non-traded REITs through a financial advisor or a real estate crowdfunding portal, but this option is a little more challenging to purchase and often has higher minimum investments, usually $2,500 or more to start.

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As you consider buying a REIT, you're probably wondering what assets you'll own. REITs collectively own more than $4 trillion in gross assets across the U.S.

You can own a piece of the estimated 580,000 properties held by U.S. public REITs, which also include 15 million acres of timberland.

REITs invest in a wide range of property types, such as offices, apartment buildings, warehouses, and retail centers.

To qualify as a REIT, a company must meet specific criteria. One of the most important requirements is that they must pay out at least 90% of their taxable income to shareholders as dividends each year.

This means that REITs have to distribute a significant portion of their earnings to investors, rather than retaining it within the company. For example, if a REIT has $100 million in taxable income, they would need to distribute at least $90 million to shareholders in the form of dividends.

To ensure that REITs are managed effectively, they must be managed by a board of directors or trustees. This is a key requirement for REIT qualification. In fact, REITs must have fully transferable shares, which allows shareholders to easily buy and sell shares.

REITs also have to meet certain ownership requirements. For instance, they must have a minimum of 100 shareholders after their first year as a REIT. Additionally, no more than 50% of their shares can be held by five or fewer individuals.

Here are the key requirements for REIT qualification: